Last Updated on November 25, 2019 at 3:41 pm
If you are going to save tax for the first time this financial year, here are some simple tips to avoid mistakes that may permanently damage your finances. The typical salaried person wakes up to the importance of money management in a structured manner with specific goals in mind only by age 30-35. By this time, enough damage is done in the name of saving tax. These tips would help a young earner avoid those.
The most common mistakes are easy to list. Buying multiple endowment policies or ulips, adding ELSS mutuals often a new one each financial year etc. That is, investments made only for tax saving would lead to portfolio clutter and it would become difficult and expensive to set things straight.
A young earner if salaried would have either EPF or NPS (in some cases both) offered by the employer. For an entrepreneur, there is always PPF. All these products can be tagged to a long term goal like retirement and can be used to exhaust most of the Rs. 1.5 lakh section 80C limit. In addition, there is the premium amount for a term life insurance premium which is also eligible under 80C.
Priorities for 1st Time Tax Savers
- Not buy any product for tax saving alone
- Use available options for saving tax and associate these with retirement goal
- In the meantime, learn more about the importance of beating inflation, goal-based investing and their money management in order.
This video may assist in recognising the importance of inflation.
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Tips for 1st-time tax savers for those who are not salaried
- They can open a PPF and invest 1.5L in it
- Get a term life insurance policy and (if necessary) use the premium amount for saving tax
- From the next FY, reduce PPF investment and invest 60% in equity and 40% in PPF
- If term insurance premium + 40% in PPF is less than Rs 1.5 Lakh then (and only then) add an ELSS Mutual fund. Use only until necessary
Tips for 1st-time tax savers for salaried with EPF or NPS
Note: NPS here refers to corporate NPS where the employer contributes to the account and not individual NPS. An individual NPS account is best avoided: Do Not Invest Rs. 50,000 in NPS for additional tax saving benefit in 2019-20! Those who to opt for the additional Rs. 50,000 tax saving can consider the steps indicated below.
- They can use the existing EPF or NPS (with pure fixed income asset allocation) and exhaust 1.5L
- Get a term life insurance policy and (if necessary) use the premium amount for saving tax
- From the next FY, invest 60% in equity and 40% in EPF/NPS
- If term insurance premium + 40% in NPS/EPF is less than Rs. 1.5 Lakh (80C) then add an ELSS Mutual fund. Use only until necessary
How to invest Rs. 50,000 in NPS without disturbing an existing investment portfolio
We have repeatedly maintained at freefincal that NPS is not a suitable investment because of its restrictive lock-in conditions. At a time when most corporate employees “retire” close to 50 or 55, the current NPS rules state that exit from NPS before age 60 will require locking up 80% of the corpus in an annuity. See this comparison with EPF to understand how this is not a fair rule: EPF vs NPS: Should you shift to NPS because the govt wants you to?
In spite of that if the illusory additional tax-saving benefit of Rs. 50,000 is important, we would suggest the following. We have pointed out that an investment amount equal to current annual expenses will have to be allocated for retirement alone! This includes the mandatory EPF/NPS deduction by the employer.
Those who wish to avail the Rs. 50,000 NPS benefit can first invest at least an amount equal to their annual expenses in a mix of EPF/PPF/Direct Equity/ Mutual Fund (equity/debt) and then try to invest Rs. 50,000 in NPS. This will ensure the restrictive conditions of NPS do not affect your retirement corpus and plans.
Perhaps this may difficult or impossible this financial year but with salary hikes, prudent spending and adding secondary sources of income, this may be possible from the next financial year.
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Dr M. Pattabiraman (PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over 14 years of experience publishing news analysis, research and financial product development.
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