Guidance on Tax Saving

1. Making long term commitments without considering all factors

Last year, Mr. Sunil had made a contribution of Rs. 36,000 towards PF deducted by his employer. So he bought a 15 year policy with an annual premium of Rs. 64,000 so that his Rs. 1 Lakh limit is achieved. However, this year, due to increase in his salary, his PF contribution has increased to Rs. 48,000 p.a. But still he has to pay Rs. 64,000 premium towards his policy. So, in effect, he is paying Rs. 1,12,000 this year towards 80C, however, he would be entitled for deduction of only Rs. 1 Lakh. This problem could continue further, as his salary is expected to increase every year and so would his PF contribution.

Similar story has occurred with Mr. Pramod. He had availed a home loan and was paying an EMI of Rs. 25,000 p.m. As per the repayment schedule, out of the total Rs. 3 Lakhs paid, only Rs. 71,000 was the principle and balance was interest. Thus, he purchased a ULIP with an annual premium of Rs. 29,000 and 5 years payment commitment. As we know, that every year, the principle component increases and interest component decreases, next year, he will have the principle component increased to Rs. 96,000 and will still have to pay Rs. 29,000 towards the ULIP premium.

If they had invested the balance amount of Rs. 64,000 and Rs. 29,000 in an avenue which does not compulsorily requires annual investment (Example ELSS, PPF, NSC etc) then this problem would not arise.

So its better to be careful while choosing long term commitment amount. You might be required to pay them for long, but wont be able to avail tax benefit on the same.

2. Thinking that all life insurance policies qualify for tax deduction

It is a general myth (mostly propagated by insurance agents) that a life insurance policy is the best thing for saving tax. Before agreeing or disagreeing to the same, I would like to draw your attention to something more important.

Not all life insurance policies would qualify for tax benefit u/s 80C. If you want to avail this benefit, you will have to ensure that the life risk cover is at least 5 times the premium paid by you. (This is as per the current tax laws. It could increase to 10-20 times the premium in DTC). Thus, if you think of following the first point and your agent starts pushing you for a single premium plan, first check if the plan is giving you a life risk cover of 5 times the premium or not. In most cases, single premium plans do not have this feature and would, therefore, not qualify u/s 80C.

There is another breed of products (of course insurance-cum-investment plan), which requires annual payments, gives 5 times life risk cover in the first year, but the cover drops to 1.25 times the premium paid from the second year. You need to be cautious while buying these plans, because, they will give you tax benefit in the current year. But the next year premium will not be eligible for tax deduction, but you still will have to pay the premium.

3. Not considering the other items that qualify for tax deduction

Before arriving at the amount you need to invest for tax saving, make sure you have accounted for few other less-known items which qualify u/s 80C. One of the most important amongst them is the tuition fees paid towards your children’s education. Also, if you are salaried, don’t forget to deduct the HRA, Conveyance Allowance (within the prescribed limits) before you arrive at your amount required to be invested to save tax. Seeking professional help for the same could be of great help.

4. Investing Blindly for just Tax saving

This tax saving season, many fly-by-night organisations (claiming themselves as NGOs) call and request you to donate them to save tax u/s 80G. While it is always good to do charity, it is also important that it is done for the right purpose and it is being used for the right purpose. Remember that out of the amount donated to such NGOs, only 50% would qualify for tax saving. Just to give an example, if you still have a taxable income of Rs. 10,000 on which you want to save tax. Suppose You are in a 20% tax slab. If you donate this amount to the NGO, Rs. 5000 will qualify for tax saving. So in effect, you will pay tax on the balance Rs. 5,000 i.e. Rs. 1000. Which means your tax saving is Rs. 1000 and total money going from your pocket is Rs. 11,000 (Rs.10000 Donation + Rs. 1000 tax)

As against this, if you do not donate, you just require to pay Rs. 2000 as tax. There is no tax saving, but the total money going from your pocket is only Rs. 2000. We are nowhere suggesting that you should not donate. But while donating, 

[A] Don’t do it just to save tax.

[B] Check the credibility of the organisation if they are putting your money to the right purpose.

i acknowledge that aforesaid article was originally posted by saurabh@nidhiinvestments.