Tip Tuesdays: Investing Just to Avoid Paying Income Tax is a Really Bad Idea

by Vinaya HS on July 28, 2009

in Finance

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I often get emails that read,

I want to invest in so-and-so financial instrument so that I can avoid paying income tax. Do you think this [financial instrument] is a good option? Alternatively, can you suggest other financial instruments that will further help me avoid paying income tax?

In my opinion, paying income tax and investing in a financial instrument ought to be independent and mutually exclusive actions. You should invest in a financial instrument only if it helps you achieve your financial goals — and no, “I want to avoid paying income tax” is not a financial goal.

Pay income tax. Define your financial goals. Invest in the right financial instruments; if a financial instrument does qualify for income tax deductions/exemptions, you just got the best of both worlds!

What do you think?

Tip Tuesdays is my initiative to share practical personal finance tips — every Tuesday. I’d be delighted if you could share a tip or two from your own experiences. Drop a comment to submit your tip. And, as always, do spread the word if you find this useful.

Thanks for reading this article. I'd love to hear your opinion. Please use the comments section below to share your thoughts. I frequently write new articles that also cover several other aspects of personal finance including credit cards, financial goals, health insurance, income tax, life insurance, mutual funds, retirement planning, and much more. You can Subscribe through Email and receive new articles directly in your Inbox or you can Subscribe through the RSS Feed and receive new articles in your feed reader.

{ 7 comments… read them below or add one }

Shilpa July 28, 2009 at 10:04 AM

I totally agree with you.

That reminds me of the people who buy a home on home loan so that they save tax. They dont mind paying interest to the bank but they have a big problem paying tax to the government – the interest generally works out much higher than the tax.

Sure, they have a house at the end 20 (or whatever) years but how many corners they’ve got to cut in that period to make ends meet and stay financially comfortable.

Vinaya H S July 28, 2009 at 10:19 AM

Very true Shilpa. I’ve often heard this argument myself. I think these ideas are penny wise but pound foolish.

Anoop August 5, 2009 at 11:29 AM

The above mentioned is one classic scenario which most of them believe, I always believed real estate is worthy enough investment in the long run(10 + years), we may end up being penny wise and pound foolish for time being, paying EMI that is higher than tax, but in return we get sanctuary whose value always increases with time, we definetely should not forget these facts. I am sure the interest we pay to banks does not increase with time?. Remember we do not have to make investments now because most of us own a house, so Vinay, I don’t completely accept your idea of being “penny wise and pound foolish”, the same perception would have been different if we did not own a house.

@ Shilpa: I do agree with your statement. On the contrary not everyone would cut financial corners while evading tax and paying high interest to banks inorder to stay comfortable, it all depends on the level of financial comfort each one has and depends on individual. For example I am not comfortable with an idea of investing in a property with borrowed money if I am going to cut my financial corners to stay comfortable, I may choose an option of paying tax and EMI equally if there is one, it may not be the case with someone else who is keen on buying a property and mostly these people are such illusions and dont know that paying extra EMI is like paying tax indirectly to government.

Vinaya HS August 5, 2009 at 12:50 PM

Anoop, what I wanted to say was…You shouldn’t invest in constructing a house just so that you can avoid paying income tax. You should invest in constructing a house only because you need a house. The fact that you get income tax exemptions for constructing your house is that “best of both worlds.”

What do you say?

Anoop August 7, 2009 at 4:03 PM

I agree! but regarding the latter part of your statement ” We get income tax exemptions”, dont you think we pay higher interests to Banks & they inturn pay the govt, we save nothing mate. I only classify assets as positive cash flow, in the above case I dont see investing in house can be considered as an asset even in the longer run, I was under the mirage that real estate value always goes up but after careful thought I now believe it all depends on the economy and varies from place to place. What do u say?

ABHISEK SEN August 20, 2009 at 8:20 PM

Dear Sir/Madam,

I have a query about investment in insurance to get benefit of avoiding paying income tax.My wife has a policy in her name in a reputed life insurance company.She pays the premium from her bank account by cheque but she is totally dependent on me.Now can I get the exclusion of paying tax of that much amount which my wife is paying as premium.

If you have the answer please let me know in my email id which is abhisek_5@yahoo.co.in.

With Regards…..

Abhisek Sen

Ragini September 15, 2009 at 6:32 PM

I completely agree. I really wonder when people take insurance policies without even considering the basics just to save tax
1. Does the person actually have any dependents.
2. You take a policy with cover for 2.5 laks and keep paying a premium of about 7-8K for 20 years.After 20 years 2.5 K is peanuts for your dependents. The Insurance company just returns the money that u kept paying them for 20 years(8*24=192).

There are obviously far better ways to save tax. Taking Insurance policy is definately one of the worst.

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