Don't let tax saving burn your savings. Here’s how to avoid last-minute investment traps

As the financial year 2024-25 draws to a close, taxpayers who have opted for the old tax regime find themselves scrambling for ways to save on taxes. While ideally, all tax-saving investments should be made at the start of the financial year, many people procrastinate until March end.

However, in the rush to meet the deadline, taxpayers often make hasty decisions, such as choosing low-return options that could prove costly in the future, choosing locked-in investments that don’t align with their financial goals, or choosing investment options with higher premiums that impact their long-term wealth.

But that's a wrong strategy. Sure, it will lower your tax bill for now, but it could leave you stuck with low returns and missed opportunities.

The decision of where to invest shouldn’t be influenced solely by tax savings. Just because an investment qualifies for a tax deduction under section 80C, doesn’t mean you should invest up to ₹1.5 lakh (which is a significant amount) into it without weighing your options.

Remember – It should be a good investment first and a tax-saving option later.

Here's how to avoid hasty, last-minute investment decisions and plan taxes while sidestepping common pitfalls.

But first things first!

Identify the best-suited income tax regime

To begin with, you need to carefully assess old and new income tax regimes and choose the one that best suits your financial profile. The choice of tax regime is crucial as it has a direct correlation with how much tax you can save.

For those who don’t know the difference between the old and new tax regime, here’s the kicker.

Under the old tax regime, you can claim several tax deductions and exemptions, such as House Rent Allowance (HRA), Leave Travel Allowance (LTA), Chapter VI-A deductions, etc., but you have to pay a higher tax rate compared to the new tax regime.

On the other hand, under the new tax regime, you can claim only limited deductions and exemptions such as the employer’s contribution towards the National Pension System (NPS) and Employee Provident Fund (EPF) but your effective tax rate is lower.

FYI: If you don’t opt for either regime, the new one will be automatically selected as a default option.

Adopt a long-term investment approach

Consider long-term benefits over short-term tax gains. Rather than adopting a piecemeal approach to tax-saving investments, align your investments with long-term financial growth, with the additional kicker of tax incentives. By combining the dual benefits of tax savings and long-term financial growth, you can make your money work more efficiently for you.

Prioritise your financial goals over tax savings

Repeat after me - tax savings should never be the sole motivation for your investment decisions. Rather, your investment decisions should be objective and need-based.

It is wise to align your investments with your financial goals (not just meet your tax-saving target). For instance, if your short-term goal is to save for a car in 3 years, blindly investing in PPF with a 15-year lock-in period would not serve the purpose. Instead, a better option would be an ELSS mutual fund, which has a shorter lock-in period of 3 years.

Once you de-clutter your mind from the tax efficiency aspect, you will be able to make a better investment decision.

*ELSS, NPS and ULIP returns may vary based on equity market performance; PPF, SSY, NSC and SCSS returns are valid till March 31, 2025; the government may revise them later.

**Some banks may offer higher returns on 5-year tax saving FDs.

Avoid investing more than required

The last-minute rush often clouds judgment, and under pressure to act fast, people end up investing in panic or putting more money into tax-saving investments than required.

To avoid this, it is best to estimate your income tax liability after factoring in already existing tax deductions such as EPF contributions, repayment of home loan principal and interest, NPS contributions within the salary package, term insurance plans, HRA deductions, etc. and then invest only the remaining amount in tax-saving investments.

Evaluate all tax-saving products

Most people decide to invest in tax-saving products based on the tax benefits in terms of the deduction it allows. But what’s equally important is to evaluate every tax-saving investment option on three broad parameters.

• Liquidity, i.e. how easily you can access and withdraw your money when you need it. You should clearly understand the lock-in period, premature withdrawal rules, and taxability on withdrawal.

• Risk of losing money: Some investment products (with equity component) are market-linked and carry higher risk compared to others. You need to evaluate your risk tolerance when investing in such products.

• Post-tax returns: You need to look at three stages to assess the tax efficiency of an investment, i.e. at the time of investment, on accrual of interest/dividend/other income, and at the time of maturity. Generally, tax-saving investments with EEE status are most tax-efficient but they have longer lock-in periods.

Stay away from insurance-cum-investing products

Many people purchase insurance policies to save tax. However, this can have detrimental effects on finances and should be avoided. Insurance and investments should not be mixed. These products do not provide meaningful returns nor do they provide adequate coverage. Moreover, the returns from insurance-cum-investment policies might not even keep pace with long-term inflation. In addition, these policies come with an investment commitment of 10 to 20 years, and in the event of premature withdrawal or policy closure, they attract a heavy penalty.

Most people treat tax-saving investments as a once-in-a-year obligation — something to quickly tick off the list before the March deadline. But the right way to approach tax-saving is to see it as a step towards long-term wealth creation, not just a shortcut to reduce taxes.