As we enter the peak tax-planning season, most of us look around for avenues to save on outflows up to the last rupee. Only 28 per cent of the taxpayers reportedly filed returns under the the old regime with deductions in FY24.

Saving on taxes is fine and even important from the point of view of shoring up your cashflows and surpluses. However, making tax-planning the central part of your financial life can lead to poor product choices and the possibility being unable to achieve money goals.

Several products – bonds, fixed-income schemes, mutual funds, insurance, home loan etc – would offer tax benefits under different sections. Therefore, carefully choosing schemes based on your own needs is critical for reaching all your targets.

So, tax planning must come within the ambit of your overall financial planning exercise.

Goal-based investing, optimal risk coverage (medical and life) and asset allocation must be the guiding forces to make your investment choices, including those that save taxes for you.

Overcrowded section

One of the most popular tax-saving section is the 80C part. Provident fund (EPF), equity linked saving schemes (ELSS), life insurance, PPF, Sukanya Samriddhi (SSY), National Saving Certificate, home loan principal and five-year fixed deposits are among the instruments that could save taxes for you.

But there is only a total of ₹1.5 lakh available under the section. For those earning higher salaries and where employers pay the full 12 per cent deduction on the employees’ income, a review may be necessary.

If your contribution and that of your employer to EPF equals or exceeds ₹1.5 lakh, you need to check if you even need any other instrument at all in the section. Any further investment apart from the ₹1.5 lakh isn’t going to save taxes for you under section 80C. So, investments must be carefully weighed in for their merits.

Goal orientation and individual needs

Any investment made must ideally be directed towards a specific life goal or any specific requirement. That would be the ideal way of deciding the right instrument based on your risk appetite and timelines.

If such investments also save taxes along the way, it is just an additional benefit, but not the primary requirement.

For example, young employees in their 20s or early 30s may find ELSS mutual funds better for their requirements as their first exposure to equities and also due to shorter lock-in of just three years. If the performance of the scheme is consistently good, they could even continue investments for longer. Or they could direct to, say, down payment for a vehicle or use it for an international holiday or even as the booking amount while purchasing an under-construction house.

Again, some employees contribute additional sums voluntarily to the EPF via the VPF. They could instead consider the NPS as a retirement vehicle that is low-cost and offers exposure to equity for very long periods. NPS investments up to ₹2 lakh enjoy deduction benefits (₹1.5 lakh under section 80C and an additional ₹50,000 under section 80CCD(1).     

An older employee could opt for PPF or SSY in such a way as to coincide the maturity with a child’s college education or marriage. The NSC or five-year bank FD can be considered by those in their mid-50s so that it matures to coincide with their retirement year and caters to their cashflows during the initial silver years.

There are tax-free bonds traded in the market, but returns are low at 5-6 per cent and liquidity is not abundant. These may not be suitable to be at the core of your debt portfolio.

Thus each tax-saving investment must have a purpose or a goal within the ambit of your overall financial goals.

Going slow in insurance

Term and medical insurance covers are the only policies that most of us need. While term insurance premium comes under section 80C, medical cover is under section 80D. The latter section allows deductions up to ₹25,000 for premiums paid for self and family and ₹50,000 if senior citizen parents are included.

But more than focusing on the deduction amount, you must choose a suitably-high (sum assured) medical cover for your requirements to include your parents, spouse and children, even if the premiums are higher than tax thresholds mentioned above.

Then, there are endowment insurance products where maturity proceeds are tax free if the annual premium is less than ₹5 lakh. But returns are low at 5-6 per cent, at most. Therefore, a thorough evaluation is necessary if they serve any specific purpose in reaching life goals, especially for the younger workforce.

ULIPs combine investments and insurance. Here again, they may not suit most investors’ requirements as charges can be high.

Instead, investors may be better off with mutual funds, which offer a wide range of categories and cater to varied risk appetites.

Aligning with asset allocation

One final and most important aspect to note is that tax planning must also align with your overall asset-allocation pattern.

For example, if you invest in too many fixed income schemes beyond even the limit available for saving taxes, it may skew your overall asset-allocation pattern towards debt.

Sovereign gold bonds can earn you reasonable tax-free returns upon maturity. However, if you overload your portfolio with these bonds, your overall portfolio returns could turn lower, thus risking your goals.

Based on your risk appetite, goal horizons and available surplus, you must continuously evolve an asset-allocation pattern – to spread investments suitably across equities, fixed income, gold etc. You can take the help of a registered financial adviser if you do not have the time or expertise yourself.

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