Don’t Rush While Picking Tax-Saving Products

With most instruments planned at macro level, ensure that individual investments meet your needs

    With the New Year starts the last three months of the financial year. And with it, for a large number of taxpayers, starts the rush to make investments in some select products that will help in reducing tax liabilities for the financial year. Quite naturally, the January-February-March period (often called the JFM period of the year) is also the time mutual fund houses, insurance companies and distributors of financial products go into an overdrive, selling investment products that qualify for tax deductions for individual taxpayers. 
    Ironically, this is also the time when a large number of investors, in their rush to make tax-efficient investments, make mistakes that they continue for long periods of time till they are eventually rectified, if at all. Some of the most popular investment products that qualify for tax deductions from your income under the Income Tax Act are public provident fund (PPF), life insurance, five-year bank FDs, National Savings Certificates (NSCs) and select mutual fund schemes. Total investment in these products, aggregating Rs 1 lakh per annum, is deducted from your total income to calculate your final tax liability. These products also come with different lock-in periods — meaning any w i t h d r aw a l from these investments before the end of the lock-in period will enhance the tax liability of the investor. So, financial planners advise against any pre-mature withdrawal, unless the same is absolutely necessary. 
    Among these products, investments in equity-linked savings schemes (ELSS) — offered by mutual fund houses — come with the shortest lock-in clause of just three years. ELSS funds come with some other advantages too. According to Sanjeev Govila, CEO, Hum Fauji Initiatives in Delhi, if you are an individual investor looking for an investment that offers the flexibility of investing in equity, debt, gold and their mix in various combinations, seamless shifting between these assets after investing, and high flexibility in terms of amount, time, tenure and method of investment and withdrawal while also being very tax-friendly and efficient — something like an ideal investment — one should look at mutual funds.
    "Within mutual funds, ELSS provide tax breaks under the I-T act's Section 80C, have the shortest lock-in among all such tax-saving schemes, while also giving long-term equity-related tax-free returns," says Govila. However, as an investor you should be aware that the government is planning for a total overhaul of the income tax structure and the tax incentives enjoyed by ELSS funds could 
be withdrawn under the new regime, which goes by the name of Direct Taxes Code, or DTC. 
    There is another aspect to ELSS funds. There is some confusion about the lock-in period for investments made in these funds through the systematic investment 
    route (SIP). The fact 
    is that the lock-in period is a rolling one from the date of each single investment and not from the date of the first investment (see Mythbuster). 
    Among the mutual fund schemes, there is another class of funds called pension funds — investments that also qualify for tax deductions under the I-T Act. There are only a handful of fund houses that offer these funds. The lock-in period in these funds are also longer. In most of these funds, which predominantly invest in debt instruments, the exit load is also lifted when the investor attains the age of 58 years. 
    Other than mutual funds, as an investor you can also look at insurance products. "An insurance policy is probably the first that comes to your mind to save tax. If you are going for a new policy, be conscious of how well it fits your need," says Vidya Bala, head, mutual fund research, FundsIndia. "As a rule, buy only those products that you understand. Ensure that you buy into a simple policy that provides adequate life cover, taking into account all your existing liabilities. Be cautious of other fancied plans, with hefty premium, as it is unclear how well they will fit the tax bill when the DTC is implemented," she adds. 
Financial planners and advisors also say that while ELSS is for those investors who can take some amount of risk, for conservative investors PPF and NSC are better options. However, the returns here are almost fixed and the chances of getting high inflation-adjusted returns are not much. "Currently, the five-year and 10-year NSCs fetch 8.7% and 8.9%, respectively. This may be a good time to lock-in as rates may change post March 2013, especially if RBI cuts interest rates," says Bala. 
"Remember, these rates are quite attractive given that interest earned each year (except the previous year) are treated as reinvestment and hence are not taxed," she points out. On the other hand, PPF is an option for long-term investors. For conservative investors, the fiveyear bank deposits are another option for reducing the tax burden. Currently, they fetching 8.5-9% per annum. A word of caution here: You should not invest only for saving taxes. "Taxsaving schemes are decided at a macro level for the nation as a whole. And individual goals and milestones need not be in alignment with the taxsaving schemes," says Mukund Seshadri of MSVentures Financial Planners. 
NEXT WEEK 
    For nearly three years now, the high rate of inflation has been bothering investors. Next week, we will explore what to expect on the inflation front in the current year and how to insulate your investments from it.