Insights

What you are not told about tax-saving products

December 17, 2018 . Gourav Kumar

The tax saving season is closing in. By the end of this month, salaried employees will be asked to submit proofs of their tax saving investments. Employees will then scramble to make their tax saving investments.

When people are in a hurry, it is the perfect time for bank relationship managers and insurance agents to missell products to them. Such investors don’t take an in-depth look at products before making their investments. They just want the process to be over quickly and fall for whatever RMs or the agents say.

So here are a few things they say to get you to invest in their products. More importantly, here’s also what they don’t say about the products and which will help you make the right decision.

  • They say: This product is risk free and offers guaranteed returns over long term.
  • They don’t say: The returns offered are revised quarterly. The money will remain locked in for 15 years

The above description is about PPF. This option is appealing if you are risk averse and if taxation is foremost on your mind. There is nothing wrong with the product itself, as long as you understand the features before investing. PPF can certainly form a part of your debt portfolio. But being a debt product, it will have lower returns. If you already have EPF contributions, going additionally for a PPF simply increases your allocation to lower-returning products.

Second, PPF interest rates and are now linked to the prevailing government bond rates. Interest rates cannot, therefore, be “fixed”or “guaranteed” since they necessarily change over the life of the PPF. EPF returns are decided based on each fiscal year’s surplus and are equally subject to change. Pick one of the two for your low-risk tax-saving investments.

  • They say: This product is just like mutual funds and also offers insurance cover.
  • They don’t say: Mortality charges are deducted for the insurance cover. Commission is also deducted, affecting your returns.

ULIP has been the go to tax saving product for agents during the last decade. It offers high commissions. The features and benefits make it the perfect product for mis-selling. ULIP, or Unit LInked Insurance Plans are basically market linked investment products which also offer some insurance cover.

However, a certain monthly fee is deducted from your investments for this insurance cover. This fee is called mortality charge and varies by the age of the policy holder. There are other charges by the names of and management fee, administration fee, etc. which are used to pay commission. Agents often show you the returns of the fund before such charges are deducted. Hence your actual returns are lower than what they showcase.

They also don’t tell you how their ULIP has done in comparison to others available in the market. They don’t tell you that, while you can switch between plans of the same ULIP, moving out of a badly-performing one and into a better one is a tedious and long-drawn out process.

  • They say: If you invest Rs. 25,000 every quarter, this policy will give you Rs. 40 Lakh after 20 years.
  • They don’t say: This product gives a return of 5.5% per year.

These statements can be linked to several insurance products, ranging from endowment and money back policies to pension products. Agents have a way of speaking in numbers which make the products look attractive. Your investments are cited as small monthly or annual figures, but the benefits are cited as a huge lumpsum figure. This creates an illusion of huge growth. However, if you look at the total amount you will be investing over the entire duration of the insurance policy and the payout, it will immediately become clear that the returns are abysmal. It is best to stay away from such traditional insurance policies.

  • They say: Money is safe in a bank FD and you get guaranteed returns
  • They don’t say: Returns are taxable and tax will be deducted at source, reducing your returns

While putting your money in a tax-saving bank deposit does keep it safe and guarantee returns, it also puts your future in jeopardy. Bank deposits generally offer some of the lowest rates of returns. This is the price you pay for the safety. Your money doesn’t grow to a sizeable amount. If you’re depending on these savings to meet financial goals down the line, you are going to find the going tough.

Many people also assume that a tax saving FD is tax-free. But that is not the case and is often not disclosed upfront. The interest you earn is taxable and TDS is deducted at the rate of 10%. This further eats into your returns. Consider the current tax-saving FD rates of 6.85-7.6%. In the 30% and 20% tax brackets, your actual return would be 4.7-5.2% and 5.4-6%, respectively.

  • They say: Invest in this tax saving mutual fund, it is issued by the bank and is safe
  • They don’t say: The bank is a sponsor for this asset management company and it is just as risky as any other AMC

Banks are not allowed to issue mutual funds. They are only a sponsor company and AMCs operate as separate entities. Being associated with a bank doesn’t make it safer. All AMCs are regulated by SEBI and pretty much every AMC also has a tax saving fund. You should compare funds and choose one that suits your needs and not invest blindly with the bank sponsored AMC. Remember that a fund that’s sporting a high 1-year return today does not automatically make it the best fund. Also remember that each fund is different and it needs to suit your needs.

These are just a few examples of how you can be deceived. And while the regulators have take a variety of steps over time, loopholes have been easy to find.

So, It is very important that you remain alert and ask questions. Ask what is so good about the product. Don’t go by verbal promises, look for confirmation in official documents. If returns are guaranteed or if there’s a payout being promised, ask how these are being generated and what the end return of the product is in annualised figures. Ask about taxation of returns, liquidity of the product, and comparisons with other products in the market. Ask about the risk levels of the product.

In short, understand what you’re getting into and how it serves your financial goals. Know that tax benefits are just that – a benefit. At the end of the day, you are deploying a good chunk of your savings into these investments. Therefore, they need to actually fit your long-term requirements.

A little bit of care while selecting your financial products will go a long way in securing your future.

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