Tax is a necessary evil in our lives. While the government needs the tax revenue to run the country, it also offers tax deductions to people for making investments in pre-approved instruments.
Have you ever wondered if these last-minute tax-saving investments are good for your financial health? While there are several tax-saving investment options, in this article, we will focus on 80C investments and look at some benefits of making tax-saving investments earlier in the financial year.
The BIG Question: Is Saving Tax at the Last Moment Good For You?
It may not be the best option. Here is a look at the disadvantages of postponing your tax-saving investments until the last moment.
Here is a short story about Rajiv:
Sounds familiar? This is the story of most of us. Here are the disadvantages of continuing this approach of making last-minute tax-saving investments:
You Lose an Opportunity to Potentially Earn Good Returns
While the core purpose of making 80C investments is getting tax deductions, it is important to remember that these are “investments” that offer returns. Hence, having the mindset of an investor (as opposed to a tax-saver) can help you make the most of the investments.
Let’s look at both scenarios and the difference in the return potential by investing at the beginning of the financial year as opposed to just before the end of the financial year.
Rajiv, a 26-year old software professional, falls in the 30% tax bracket and decides to make full use of Section 80C to get a tax deduction.
Scenario I – Investments in fixed-income instruments under Section 80C
Let’s say that Rajiv invested in all these instruments in the following manner:
- PPF – Rs.50,000 @ 8% p.a.
- Tax-Saving FD – Rs.50,000 @ 7% p.a.
- EPF – Rs.50,000 @ 8.5% p.a.
Let’s talk about the financial year 2020-21 and look at the potential returns at the end of 15 years if Rajiv had invested for all 15 years starting April 2020 (beginning of the financial year) vs. February 2021 (end of the financial year):
|Investment||Amount||Interest Rate||Maturity amount as of February 2036|
|PPF||50000||8%||Investment made in April 2020:||16.17 lakh|
|Investment made in February 2021:||14.66 lakh|
|Tax-saving FD||50000||7%||Investment made in April 2020:||14.75 lakh|
|Investment made in February 2021:||13.44 lakh|
|EPF||50000||8.5%||Investment made in April 2020:||16.93 lakh|
|Investment made in February 2021:||15.32 lakh|
As you can see, despite investing the same amount with the same rate of interest, the potential returns that Rajiv can get can be reduced by around Rs.1-2 lakh.
Learning: Most experts say that timing the market is not as important as time in the market. The value of money also reduces with time. So an early investment versus a late investment may be beneficial.
Please Note: It is important to note that PPF interest rates are fixed for every quarter and can change. Also, EPF rates are fixed for every year and tax-saving FD rates are fixed for the tenure they are booked for. We have taken the same rate across all years for calculation simplicity.
Scenario II – Investments in market-linked instruments under Section 80C
Market-linked instruments can never be predicted. You will not be able to say with certainty if the markets will be performing better during April when the financial year begins or during January to March when the year is about to end. Waiting for markets to perform better to invest has been marked down as not so wise decisions by experts like Warren Buffet as well.
Haste Makes Waste
When you put off tax-saving investment decisions until the last moment, you are pressed for time. This means that you don’t have the time to research investment avenues and analyze them before making a decision. You are pressed by a deadline. This rush can lead to mistakes that can hurt your financial portfolio in the long-run.
While this investment might help you save tax, it might not be in sync with your financial goals, risk tolerance, or investment horizon.
Things That Can Go Wrong In Hasty Decision Making
You may end up picking a ‘wrong’ fund
Indians love saving taxes. When there is a deadline knocking on your door that is a potential option to help you save money, you would not want to lose out on that opportunity. And rightly so, why lose out on a tax-saving opportunity? However, in haste, you may end up picking a fund that looks lucrative on the basis of half baked research.
The fund might be riskier than your own risk appetite. When a moderate risk tolerance person invests in a risky investment, he or she may not have the standing to absorb short term volatilities and losses. He or she may not have time at their hands to let risks even out. Hence a risky investment for a moderate risk-tolerant person can be damaging.
While ELSS schemes broadly borrow the risk tolerance of the equity markets, a lot depends on the holdings of the fund. Do remember that holdings change as and when the fund manager wants them to. Hence, looking at the portfolio of an ELSS scheme is one of the many factors that you should consider before investing.
Let’s say you have not invested at all and you suddenly realise right before the end of the financial year that you need to invest.
What if you don’t have Rs 1.5 lakh ready with you in your bank account?
What if you have to withdraw any other investments you had made in the past to account for your tax deductions?
What if those past investments are not sitting at hefty returns? Or maybe even at a short term loss?
These questions will make you realise that quick planning can do no good.
Saving tax at the last moment can lead to:
- A loss of potential opportunities to earn better returns
- The risk of making wrong investment decisions in haste
- Investing in a lump sum at the wrong time when markets are riding higher valuations
- Cash crunch at the end of the year
A planned approach to tax-saving investments can help avoid these drawbacks with ease.
FAQs about last-minute tax-saving
Q1. What tax-saving options can I consider?
Answer: Even if you don’t have much time, try going through the list of tax deductions available to you. The government offers tax benefits for certain investments and expenses. Get your hands on this list for the current financial year. This is easily available online.
Q2. What can I do if I don’t have enough funds to invest in tax-saving instruments?
Answer: While most articles talk about tax-saving investments, there are certain expenses that offer tax benefits too. Some such benefits are tax deductions for expenses made on:
- House rent
- Children’s education (tuition fees)
- Children’s hostel expenditure
- Transport to and from your house to your place of work
- Conveyance costs for performing your job, etc.
You can go through the entire list on the website of Income Tax or ask your HR team to forward a list of approved deductions. These deductions can help you bring your tax liability down and you might be able to drop to a lower tax bracket by making a smaller investment.
Q3. Isn’t investing in tax-saving fixed deposits the simplest option?
Answer: A tax-saving fixed deposit offers fixed returns as it is not linked to the market. However, according to the latest rates, these FDs are offering interest at the rate of 5-6.75% per annum. This is much lower than the returns offered by other investment options like PPF (7.10%), EPF (8.5%), and ELSS schemes (double-digit returns). Further, the inflation rate in India varies between 5 and 6%.
Since these tax-saving investments have a lock-in period, by the time you redeem them, if the returns are not higher than the rate of inflation, then your funds will lose some amount of buying power. Even if you have a low tolerance to risks, PPF/EPF can offer slightly better returns than tax-saving FDs. Remember, it is important to choose investments based on your financial goals, risk tolerance, and investment horizon.
Q4. What are tax proofs and when do we have to file them?
Let’s take the example of the financial year 2020-21. For the income earned between April 2020 and March 2021, you are liable to pay taxes too. If you want to save taxes, you will have to make tax-saving investments within that timeline only, unless there is any special provision by the government.
When a financial year begins, companies ask their employees to file a tax declaration form. You use this form to declare what investments you may make this year. Accordingly, your company deducts TDS from your salary throughout the year.
By the time January comes, the company will ask you for proof of those investments you had declared in April.
Say you had declared you would invest Rs 1 lakh in ELSS and ended up investing only Rs 50,000. Throughout the year until January, the company may or may not have deducted TDS depending on your salary and Rs 1 lakh declaration.
When the time comes to provide investment proofs, if you show an investment worth Rs 50,000, your company will compensate by deducting more TDS in the months to come before the financial year ends.
If you are able to show the proof, your company may stay put depending on any salary revisions, bonuses, etc.
Tax returns: This is where tax returns come into the picture. Suppose you do end up investing another Rs 50,000 in tax saving instruments later on. This makes your total investment Rs 1 lakh. However, assuming that this investment was made after filing tax proofs in your company, you can claim a refund while filing your returns from the income tax department.