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Short of cash? Don’t borrow to invest in tax-saving avenues

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Many look at tax-saving as a chore and invest in tax-saving instruments towards the end of the fiscal without aligning them to their other investments.

Some even borrow to buy or invest in tax-saving instruments if they are short of funds. The reason: If an individual in the highest tax bracket exhausts the 1.5 lakh limit available under Section 80C, there could be savings of up to 46,000 in taxes. Even if the taxpayer takes a loan at 16-18%, there would still be some savings.

The amount of saving that is possible may look attractive. But it’s not feasible if you look at the implications of borrowing. There is a cost attached to a loan. Even if you take money from a relative or a friend where you are not paying any interest, your finances are going to be affected.

Employers deduct tax every month from employees’ salaries. If an individual plans tax-saving at the last minute, he or she will need to claim a refund for the extra taxes paid after filing income tax. Income-tax refunds take time.

The bigger problem is that borrowing can lead you into a debt trap. When you borrow, it means you are unable to pay for the tax-saving instruments from your pocket. “The EMIs (equated monthly instalments) of a loan will further put pressure on your income. You may need to borrow more to meet some other obligations, leading you into a debt trap,” said Arvind Rao, chartered accountant and founder of Arvind Rao and Associates, a Sebi-registered investment advisory firm.

According to Rao, while one should avoid borrowing, it’s understandable if the person borrows from a close relative or friend in case there’s a shortfall. Say, a salaried person had to invest 1.2 lakh for Section 80C deductions. He’s short of 20,000, which he borrows. “The idea is that money borrowed should be replenished when he gets the April salary. Otherwise, the person will go on repeating the same thing every year,” said Rao.

Borrowing to invest in ordinary circumstances is not a good idea. The same risks apply even if you plan to borrow to invest in tax-saving products, despite the tax benefit. You need to have a great deal of financial discipline to repay the loan, which will not be easy for someone who was not disciplined enough to start with and didn’t save regularly.

Tax saving needs to be a part of your overall financial plan. For example, you should invest in Public Provident Fund before the fifth of each month to get interest payment for that month. In the case of ELSS, investing through a systematic investment plan, or SIP, will work in your favour as it will average out your purchase price.

It’s better that you don’t save tax this year if you have to borrow. Plan better from April for the next financial year.

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