Tax-saving should be a year-long process to avoid making certain mistakes that could prove to be counter-productive to your long-term financial goals
Many blindly invest in insurance-cum-investment products like traditional insurance plans and endowment policies to save tax at the last moment
With FY 2020-21 coming to an end in a few days, many who have not yet accomplished their tax-saving goals will now be aggressively exploring various investment options to maximise the tax deduction benefits at their disposal. Tax-saving should ideally be a year-long process and not a last-minute exercise to avoid making certain mistakes that could prove to be counter-productive to your financial goals.
Here are a few mistakes you should avoid when making last-minute tax-saving investments.
Do you know how much you exactly need to invest in the tax-saving instruments this year to reduce your tax liability? Estimate your expected total income for the current financial year after factoring in all your income and accordingly ascertain the total tax-saving investments you need to make in the current financial year. Adjust the tax-saving investments you have already made in the year to determine the exact amount to be spent on tax-saving measures. Investing more than what’s required could disrupt your journey to achieve your financial goals in time while disturbing your core savings could leave you vulnerable to any emergency.
Investing in insurance-cum-investment products
Many blindly invest in insurance-cum-investment products like traditional insurance plans and endowment policies to save tax at the last moment. However, these plans often fetch lower returns than pure investment instruments like ELSS, PPF, etc. and their life cover is significantly less than a plain vanilla term insurance policy that usually carries lower premium obligations too.
Moreover, traditional insurance policies often require a very long-term investment commitment and you will incur heavy losses if you surrender them during the initial years. As such, it’s wiser to keep your investment and insurance goals separate measures. You may go for ELSS, VPF or other small savings schemes for investments in line with your returns expectations, liquidity requirements and risk tolerance and a term plan or a health insurance plan for your insurance requirements.
Investing using borrowed funds
Tax saving is a crucial financial step, but you mustn’t exceed your financial capacity while doing so. Spending more than what you can afford can create unnecessary debt and hurt your finances. Most people are still recovering from Covid-19-related financial stress, and they continue to have a higher liquidity requirement. So, taxpayers should try to strike a balance between tax-saving and liquidity needs at this point. Some taxpayers go to the extent of borrowing money to accomplish their tax-saving goals; but you should try to avoid it.
You may borrow to invest in a tax-saving scheme only in situations when you have a very short-term liquidity crunch like salary getting delayed by a few days or you expect a payment to get credited in the next 10-15 days. Avoid using borrowings like a personal loan or withdrawing cash through a credit card to invest in tax-saving schemes. If you must, you may consider borrowing money from friends and relatives or use an overdraft facility against FDs or any other eligible investment. If any of your investments have matured, you can also use that fund to invest in a tax-saving scheme. However, you should first aim to invest in tax-saving measures out of your own savings without disturbing other important financial obligations.
Not factoring in your financial goals
Do not spoil your financial goals for investing in a tax-saving scheme. Select a tax-saving product that can help you achieve your financial goal in the long-term. Never align tax-saving investments with your short-term financial goals because all tax-saving investments have a lock-in requirement which may range from three years to around 15 years, and you can’t usually liquidate them before the lock-in period is over.
Not diversifying your tax-saving investments
Diversification can help you reduce the risk to a great extent when you invest money, whether it’s a tax-saving investment or a regular investment product. Due to the last-minute rush, many often put their entire fund into a single asset class. So, while investing in a tax-saving instrument, you should ideally diversify your funds across different asset classes and different schemes within the same asset class. For example, instead of putting all your money in an ELSS (that carry medium to high risks), you may diversify by investing in NPS, tax saver FDs, PPF, gold, etc.in addition to ELSS to minimise the overall investment risk in the long term and get the desired returns.