Fallibility of Tax Saving Instruments

Fallibility of tax saving instruments | PROCYON ...
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FALLIBILITY OF TAX SAVING

INSTRUMENTS
GALLERY | JULY 11, 2013 | NARENDRA KONDAJJI | 0 COMMENTS
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How good are the specic nancial instruments which get you tax benets? Do they serve
their purpose today and tomorrow as well? This write-up analyses the fallibility of many tax
planning schemes you may have:
fancied highly,
subscribed to or bought,
been cajoled to subscribe by some of the most intense sales and marketing efforts.
Investors portfolios may have myriad tax saving and investment schemes. Investment linked
insurance policies take the pride place among all such products. Next in the line will be
pension or retirement or Education and such labelled products. They will have a life span
ranging from 5 to 30 years or sometimes, even beyond. You will accumulate these products in
such a time when tax planning is the primary criterion. You cant decide if it is good to club
long-term investment options with tax planning or not. Typically, these products are eligible
for exemption under various sections of Income Tax, some of the important sections being
80C, 80CCC and 80CCD.
Do they really help you in achieving your goals or do they make you
fall between two stools because of:
inferior returns,
high costs of ownership, and
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Friday 03 January 2014 11:52 PM
limiting conditions
What do the tax rules say?
To fully comprehend the gravity of the situation, we have to look into some of the Income Tax
provisions. In general, Indian Income Tax Act allows for deduction of Rs.1,00,000/- (at
present), if you invest a similar sum in the specied schemes or instruments. They are grouped
under the Sections 80C, 80CCC and 80CCD of Income Tax Act. Some examples are:
Life insurance policies
Deferred annuity plans
Approved superannuation schemes
National Savings Certicates
Public Provident Fund Account
Equity Linked Saving Schemes (Mutual Funds)
5-year xed deposits
Pension funds/Pension Schemes
You buy or invest in the above mentioned schemes because, you can:
Get tax exemption up to Rs.1 Lakh every year
buy income protection (life insurance)
do saving
buy long-term investments for specic goals (retirement, children education)
Emphasizing the tax exemption part, and illustrating how it boosts your total returns is one of
the surest tricks the producers and sellers of these products play upon you. You will be told
that these products provide you tax exemption for their life, that is, as long as you are paying
the regular premiums or installments.
The Triad your savior
Chapter VIA of Income Tax Act is a mlange of several kinds of cash outows, especially in the
case of salaried person. In addition to some of the schemes/instruments listed above, there
exists a curious triad. First member of the triad is the statutory contribution
to Recognized Provident Fund Account; sometimes, you can also contribute additional sum to
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this account under what is known as voluntary contribution option. Next is the tuition fee,
an expense item. The third cash outow is neither a mandatory saving scheme nor an
expense. It is actually capital outow in the nature of repayment of housing loan. If you just
take a pause and reect on this triad, you will realize that:
a) Provident Fund contribution is a percentage of your basic salary, usually 12%, which
means, as your basic salary increases, your contribution also increases year-on-year.
Moreover, this contribution is a mandatory one, and it will continue till the end
of employment or retirement.
b) Tuition fee is also a necessary expense you will begin to incur from the time your child
starts attending a school. It will continue till your child completes her college or post-graduate
education.
c) At some point in your life you will build or buy one, or sometimes more than one, house
property. If you borrow a loan for this purpose, then you are likely to have the cash outow for
a term ranging from 10 to 30 years. This cash outow has two components:
1. Interest, and
2. Principal repayment
How much you need to qualify?
Now, let us check the qualifying amount for each year. As per existing tax provision, you may
claim a deduction up to a sum of Rs.1 Lakh each year. How long it may take you to cover this
amount fully using the above triad alone? Empirically, I can say by the time you are in your
mid-thirties. Later, you will not need the crutches of any specic tax planning instruments till
the end of your career because the cash-outow towards the tax saving triad will meet your
requirements. What happens to the bouquet of nancial products you have collected with so
much care over all those years, and what happens to the returns projections which rely heavily
on the tax exemptions you get? Well, all the projections go kaput. Here is a hypothetical
illustration of one of the possible scenarios:
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Note: Basic salary to increase at the rate of 5% every year

The above illustration uses very conservative numbers and you will notice that the utility
of specialized tax planning instruments will be over in just 11 years, i.e., at around the age 35.
Subsequently, the tax saving triad will take care of your tax planning requirements till you
retire.
You should also keep in mind several assumptions under which the preceding calculation holds
true, the important one being the tax rules remain unchanged all through. I think this is a fair
assumption to make because the nancial instruments also make the same assumption in the
rst place.
Look before your leap
Conclusion is that you should not commit your
hard-earned money to an inferior product with a long
life-cycle in the name of tax planning or tax saving because
you will not need them for too long really. One or more
members of the tax saving triad will help you.
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Does this mean that the long-term schemes are no good tax
savers? May not be entirely or all of them. Please be very
selective when buying them, and also account for
mandatory or necessary cash outows that are bound to
occur in different stages of your life. You should analyse and
understand how truly such products serve the intended
purposes to the entirety of their life. Dont just fall for the
sales hype in a hurry only to regret at leisure later.
It also makes sense if the product manufacturers make their products stand on their own
merits and do not depend on transient benets which may or may not happen. Only then we
can say that the nancial products have reached a stage of maturity, a very much-needed
status for the nancial services industry.
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