When paying makes more sense

To save tax, a lot of investors end up buying instruments that are quite useless and expensive

Between December and March, employees go on an overdrive to save tax. A problem Nitin Vyakaranam, chief executive officer of ArthaYantra.com, realised when giving a talk on financial planning to a company. Even the junior employees with salaries of Rs 6 lakh and less were willing to go all out, even take a personal loan or use credit cards, to buy instruments that would save their tax.

The best part: All that rush was to save just Rs 1 lakh under Section 80C. “Ideally, tax planning should be done at the beginning of the year. If you do not understand the subject, seek help. Instead, most wait till the last moment and take help from friends, colleagues and family members, who might or might not be qualified,” said Vyakaranam.

In such cases, a loan on a credit card becomes an easy option because you will get the money immediately. But you end up paying huge interest that can be as high 30-40 per cent a year. Even if you take a personal loan, the rate of interest you are charged is 15-18 per cent. But if you don’t make tax-saving investments, you will pay taxes at slab rate. So, paying tax is more cost effective.

For instance, assuming your annual salary is Rs 6 lakh, and the annual contribution to the Employee Provident Fund (EPF) is Rs 28,800 a year (at the rate of 12 per cent of the basic salary). You fall in the 20 per cent tax bracket. So, you have to save Rs 71,200 to reach the limit of Rs 1 lakh.

Now, if you do not make any tax-saving investments, the tax to be paid works out to Rs 45,567.2. If you make the required tax-saving investments, the tax to be paid works out to Rs 30,900. So, you saved Rs 14, 667.2 if you invest Rs 1 lakh.

Assuming you borrowed Rs 71,200 at a rate of 18 per cent for two years, the total repayment (including processing fee and interest) works out to Rs 15,110.4. The monthly repayment comes out to about Rs 3,554.6, which means your salary reduces by that much.

On the other hand, if you pay tax without making any investments, your monthly salary will be reduced only by Rs 1,222.27, as you lose only Rs 14,667.2, if you don’t invest Rs 1 lakh.

Most of us realise we need to make our investments only when we get the mail reminding us from the human resource department. That is why we end up investing in costly insurance policies, which become difficult to service later, or investing in tax-saving mutual funds that might not earn good returns. The only way to avoid this is to plan your taxes right from the beginning of the year and do it systematically.

“For most of us, the contribution towards EPF or home loan repayment will take care of a lot of the requirement under Sec 80C. But we tend to save excessively in tax-saving instruments. The question is whether you need to do it? Always look at the product and ask why it has to be bought (or invested in),’’ said Arvind Rao, a certified financial planner.