Avoid tax planning in last days

Taxes | admin | February 4, 2011 at 6:50 pm

Aamir Humayun looks forward to holidays because they help him unwind and let him spend time with his children. But the public holiday for Mahavir Jayanti in 2007 put the Delhi-based businessman in a quandary. It was 31 March and Humayun had not finished his tax planning. “All banks and post offices were closed. There was just no way I could save tax,” he says.

So his chartered accountant stepped to help. One call to an insurance agent and a few signatures later, Humayun’s tax planning for the year was done. He and his wife had been sold two unit-linked insurance plans with an annual premium of Rs 1 lakh. “I was told that I would have to invest only for three years and that my investment would grow to about Rs 48 lakh in 20 years,” says Humayun.

The agent, who was incidentally the chartered accountant’s wife, conveniently glossed over the fact that these were only projections and based on the ridiculous assumption that stock markets would rise 18-20% every year in the next two decades. When the markets crashed in 2008, the value of Humayun’s investment plummeted. He has paid premiums for four years and the fund value is barely in the green. “Now these insurance premiums have become millstones around my neck,” he says in disgust.

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Aamir Humayun, 41 Delhi
Invested: Rs 1 lakh in two Ulips
His mistake: Started tax planning in the last week of the financial year

A flurry of bank holidays in the last week of March in 2007 upset the tax planning schedule of this Delhi-based businessman. With no option left, he agreed to buy two insurance policies, which turned out to be market-linked plans. The agent painted a rosy picture based on the past returns. In the 2008 crash, the value of his investment plummeted sharply. He now rues his decision to buy the policies.

The only cold comfort for Humayun, if at all, is that he is not alone. Millions of taxpayers across the country compress their entire year’s tax planning into one month. For salaried taxpayers, the tax-saving season kicks off when they get a note from the accounts division on how much they need to invest. With it comes the warning: give proof of investments or get ready for a hefty tax deduction at source (TDS). “That’s the time when undisciplined investors start running around like headless chicken,” says a financial planner.

In the rush to invest before the deadline, taxpayers often make fundamental investing mistakes, which they rue for years to come. Gurgaon-based software professional Ashwin Arora knows the perils of just-in-time tax planning. Three years ago, he was working with a large global consulting firm that gave him less than two weeks to show proof of his investments. “My company asked for proof by the end of the calendar year and I had only my provident fund contribution to show,” he says. So, Arora promptly invested Rs 33,000 in three tax-planning mutual funds at one go. This was just a few days before the markets went into a tailspin in 2008. “The three funds are good performers but my investments are still in the red,” he says glumly. Small investors should not put large amounts as a lump sum in equities. It’s best to stagger the investment in monthly SIPs.

Ashwin Arora, 28 Gurgaon
Investment: Rs 33,000 in three ELSS funds
His mistake: With tax-saving deadline staring, invested a lump sum in three funds, all of which are running in losses.

When his company asked him to show proof of his tax-saving investments, Arora put `33,000 in three tax planning mutual funds at one go. This was just a few days before the markets went into a tailspin in 2008. Small investors should not put large amounts as a lump sum in equities. A staggered approach of monthly SIPs is a better strategy.

More importantly, experts say tax planning should be a part of the individual’s overall financial plan. In other words, the investment choices should not be governed by the potential returns they offer but by their ability to fit into the asset allocation of the individual. “One should choose the option depending on one’s risk appetite and asset allocation,” says Pankaaj Maalde, a financial planner working with Mumbai-based Sykes & Ray Financial Planners. Invest in the Public Provident Fund (PPF) if you need long-term debt in your portfolio. Go for NSCs, fixed deposits and infrastructure bonds if you want medium-term debt. Buy ELSS funds if you want equity exposure. And take an insurance policy if you require life cover.

The best way to assess the suitability of an investment option is to look at it without the tax-saving benefits. “The tax benefits should be seen as the icing on the cake, not the cake itself,” says PV Subramanyam, financial trainer with Iris. Simply put, the tax deductions under Section 80C are only incentives provided by the government to encourage savings.

Do you need an insurance cover? Would you buy an insurance policy if there was no tax incentive? If your answer to both the questions is yes, go ahead and buy a policy. Similarly, ask yourself if you need to invest in equity funds. Or in fixed deposits. Once you are able to define your needs, you will be able to choose the right option.

These cardinal rules of investing are quickly forgotten in the rush to meet the investing deadlines set by employers. Who has the time to sit down and weigh the choices when time is running out. Delhi-based Jasneet Bedi is 31 years old, earns a six-figure salary and is aware of the potential of equities to create wealth. But when it comes to her tax savings, she just puts Rs 70,000 in her PPF account. “I have been wanting to invest in ELSS funds but never have the time to sit down and research which is the best scheme,” she says.

Debarati Ghosh, 30, Kolkata
Invested: Rs 50,000 in Ulip
Life cover: Rs 2.5 lakh
Utility: Nil. The life cover is too small.
Her mistake: In a hurry to save tax, didn’t check if the product suited her.

She invested in a Ulip three years ago because a friend was selling it. The Ulip gives her a very small cover that’s barely equal to her four months’ salary. With her parents to look after, she needs a cover of at least Rs 30-40 lakh. Had she opted for an ELSS fund, her gains would have been higher.

What she doesn’t realise is that she is losing out on a terrific opportunity to create wealth by combining her tax investments with financial planning. Had she done that, the ELSS option would have been more compelling than PPF. Or it could be a good complement to the PPF. Like her, many taxpayers find it infinitely easier and less tasking to believe the friendly broker and sign where he has marked ‘x’ on the application form.

Others are led by non-financial reasons to opt for unsuitable options. Kolkata-based sales executive Debarati Ghosh invested in a Ulip three years ago because a friend was selling it. “He even gave me Rs 8,000 in cash in the first year on my investment of Rs 50,000,” she says. Her Ulip has done fairly well and the fund value has grown to almost Rs 2 lakh. But Ghosh also realises that had she opted for an ELSS scheme, she would have earned much higher returns.

Many of us are guilty of such friendly mistakes. Two years ago, Arora bought a Ulip on the advice of a broker even though he didn’t have any financial dependants. He’s paying Rs 16,000 a year for a life cover of Rs 3.2 lakh and has vowed not to buy a unit-linked plan ever again. “I made a mistake, but have to continue with it otherwise I will end up paying heavy surrender charges,” he says.

Rohit Ruia, 35, Mumbai
Invests: Rs 2 lakh in endowment policies and Rs 50,000 in a Ulip.
His mistake: Bought additional life insurance cover he didn’t need.

He has several endowment policies that combinedly give him a cover of Rs 2 crore for an annual premium of Rs 2 lakh. Even though this is sufficient, his broker sold him a Ulip six years ago. The Mumbai-based businessman has now become investment savvy and has sought help from a certified financial planner.

Often, the friendly adviser is not acting in the best interests of his client. Humayun’s chartered accountant did not point out that he needn’t have bought the insurance policies. The tuition fees of his two daughters would have sufficed. Mumbai-based businessman Rohit Ruia has endowment insurance policies that give him a cover of Rs 2 crore for an annual premium of Rs 2 lakh. Though this was sufficient for his needs and he didn’t require any more tax-saving investments, his broker sold him a Ulip six years ago. “This portfolio suggests that all the investments were ad hoc and done in a hurry without giving a thought,” says Kartik Jhaveri, director of Transcend Consulting, a Mumbai-based financial planning firm.

Chandigarh-based Dhiraj Gupta has also made the same mistake but he has learnt how to make the most of it. He bought an endowment insurance policy when he started working around nine years ago and pays Rs 35,000 a year for a life cover of Rs 7.5 lakh. “I know I made a mistake but terminating the policy now will not serve any purpose. So I treat the premium as an allocation to debt in my financial portfolio,” he says. For life insurance, he has bought a term plan that covers him for Rs 70 lakh.

Six steps to help you avoid investment blunders

Formulate a plan:

At the beginning of the financial year, chalk out how much you intend to invest in different asset classes. Then spread out this amount across the next 10-12 months.

Choose correctly:

Invest in a tax-saving option on the basis of your overall financial planning. Choose an investment only if it helps you meet a certain financial goal (retirement, child’s education, insurance cover).

Automate your investments:

Set up an ECS mandate for your investments in ELSS, Ulips and other options. This will ensure that even if you forget to invest every month, your bank will not.

Avoid long-term plans:

Don’t buy insurance products in a hurry. These are long-term products and one needs time to assess and compare the features. Do not commit yourself to multi-year payments.

Know your deductions:

Take into account deductions such as tuition fees of children and home loan repayment while calculating how much you need to save under Section 80C. Many taxpayers don’t even know how much they have contributed to the Provident Fund during the year.

Avoid health cover only to save tax:

Everybody needs health insurance. That’s why the government gives you a deduction for the premium. Don’t see this as a tax-saving idea. Buy a plan only after careful consideration of its features and clauses.

Source: Economic Times