- Date : 27/02/2020
- Read: 5 mins
- Read in हिंदी: क्या है जो टैक्स सेविंग को एक महत्वपूर्ण वित्तीय योजना बनाता
Learn why tax planning is so important and why you need to understand it to ensure your financial planning is rock solid
Benjamin Franklin had once famously quipped, “In this world nothing is certain but death and taxes.”
Tax-planning is an obligation that every law-abiding citizen has to fulfil by accounting for all sources of income and accounts payable. However, they can do so while taking advantage of all permissible deductions, exemptions and rebates available under the prevailing tax laws.
Rather than looking at it as a burden, citizens should use various provisions under the Income Tax Act to structure and plan their finances judiciously. Instead of making ad-hoc investments as the financial year closes or investing just to save on tax as a temporary goal or towards an ill-conceived objective, they can adopt a tax planning method that will reduce their tax liability, preserve capital and assist them in long-term wealth creation for various goals set at different life stages.
Choosing the right tax-saving vehicle rests primarily on four primary factors. Additionally, it is equally important is to choose a tax-saving instrument which can be linked to a specific goal. The four factors are outlined below:
How to avail tax benefits
One may consider Section 80C (with subsections 80CCC and D) which allows annual tax benefits of up to INR 1.5 lakh eligible for investments in one or more financial instruments or as deductions for specified expenses.
The eligible investments for tax deductions include life insurance,equity-linked savings schemes (ELSS) mutual funds, Public Provident Fund (PPF), National Savings Certificate (NSC), tax-saving term deposits, tax-saving government bonds etc.
The expenses and outflows that can be used as deductibles include tuition fees, principal repayment of home loan, construction or purchase of new house property among others.
If taxpayers have exhausted their annual investment limit of INR 1.5 lakh, they can now also look at National Pension System (NPS) or the Atal Pension Yojana to save for their retirement and in the process save additional tax under Section 80CCD(1B) up to INR 50,000. For someone in the highest 30% income tax bracket, it works out to an additional annual saving of about INR 15,000.
Premium paid towards a health insurance plan and preventive health check-up for self and family members qualifies for tax benefit under Section 80D for INR 25,000 and INR 30,000 for those above 60. In fact, the total deduction available under section 80D for self and dependants is INR 65,000.
If one has a home loan, interest payments made towards its repayment can also be claimed under Section 24. The other deductions include donations under Section 80G, and interest payments under Section 80E for education loan, among others.
Related: Things you didn't know about tax-saving [infographic]
Types of tax-saving instruments
Within the basket of Section 80C investments, there are two options to choose from – ones with ‘fixed and assured returns’ and ‘market-linked returns’.
The former primarily consists of debt investments, including notified bank deposits with a minimum period of five years, endowment plans, PPF, NSC, and senior citizens savings scheme (SCSC).
The ‘market-linked returns’ category is primarily the equity-asset class. Here, one can choose from Equity-Linked Savings Scheme (ELSS) of mutual funds and the Unit-Linked Insurance Plan (ULIP), including pension plans and the NPS.
Tenure
All the above tax-saving instruments are medium to long-term products in nature – ELSS come with three-year lock-ins while PPFs come with a 15-year lock-in.
Taxability of interest
Another important factor to consider is the post-tax return of the tax-saving investment. For instance, most fixed and assured returns products such as NSC provide you with Section 80C benefits but the returns, currently 7.6% (five-year) annually, are taxable. This makes the effective post-tax return equal to 5.32% for the highest taxpayers.
Considering an annual inflation rate of 6%, the real return, in this case, is almost zero! Inflation erodes the purchasing power of money, especially over the long term.
Of all the tax-saving tools, only PPF, EPF, ELSS, NPS and insurance plans enjoy the EEE status, i.e., the investment is tax-exempt during the three stages of investing, growth and withdrawal.
Making the right choice
First, identify a goal, medium or long-term. If you need funds in the near future, opt for a fixed income instrument. An equity-backed tax-saving instrument would suit long-term goals as equities need time to perform.
Ideally, try to opt for a tax-free investment. And, before considering a taxable investment, see the tax rate that applies to you and consider the post-tax return. A low post-tax return after adjusting for inflation will not help you in achieving your goals in the long run.
Related: What are tax-free bonds and how do they work
Conclusion
Efficient tax planning should ideally begin at the start of every financial year. Remember, the risks of planning tax-saving in a hurry later are manifold. There is, for instance, a high probability of picking up an unsuitable product, not investing according to the goals and miscalculating tax benefits.
Also, it is important to remember that there is no one instrument that can help you save tax and at the same time also provide safe, assured and the highest returns.
Your final choice should ideally be based on a gamut of factors rather than solely being driven by returns from the financial product.
Benjamin Franklin had once famously quipped, “In this world nothing is certain but death and taxes.”
Tax-planning is an obligation that every law-abiding citizen has to fulfil by accounting for all sources of income and accounts payable. However, they can do so while taking advantage of all permissible deductions, exemptions and rebates available under the prevailing tax laws.
Rather than looking at it as a burden, citizens should use various provisions under the Income Tax Act to structure and plan their finances judiciously. Instead of making ad-hoc investments as the financial year closes or investing just to save on tax as a temporary goal or towards an ill-conceived objective, they can adopt a tax planning method that will reduce their tax liability, preserve capital and assist them in long-term wealth creation for various goals set at different life stages.
Choosing the right tax-saving vehicle rests primarily on four primary factors. Additionally, it is equally important is to choose a tax-saving instrument which can be linked to a specific goal. The four factors are outlined below:
How to avail tax benefits
One may consider Section 80C (with subsections 80CCC and D) which allows annual tax benefits of up to INR 1.5 lakh eligible for investments in one or more financial instruments or as deductions for specified expenses.
The eligible investments for tax deductions include life insurance,equity-linked savings schemes (ELSS) mutual funds, Public Provident Fund (PPF), National Savings Certificate (NSC), tax-saving term deposits, tax-saving government bonds etc.
The expenses and outflows that can be used as deductibles include tuition fees, principal repayment of home loan, construction or purchase of new house property among others.
If taxpayers have exhausted their annual investment limit of INR 1.5 lakh, they can now also look at National Pension System (NPS) or the Atal Pension Yojana to save for their retirement and in the process save additional tax under Section 80CCD(1B) up to INR 50,000. For someone in the highest 30% income tax bracket, it works out to an additional annual saving of about INR 15,000.
Premium paid towards a health insurance plan and preventive health check-up for self and family members qualifies for tax benefit under Section 80D for INR 25,000 and INR 30,000 for those above 60. In fact, the total deduction available under section 80D for self and dependants is INR 65,000.
If one has a home loan, interest payments made towards its repayment can also be claimed under Section 24. The other deductions include donations under Section 80G, and interest payments under Section 80E for education loan, among others.
Related: Things you didn't know about tax-saving [infographic]
Types of tax-saving instruments
Within the basket of Section 80C investments, there are two options to choose from – ones with ‘fixed and assured returns’ and ‘market-linked returns’.
The former primarily consists of debt investments, including notified bank deposits with a minimum period of five years, endowment plans, PPF, NSC, and senior citizens savings scheme (SCSC).
The ‘market-linked returns’ category is primarily the equity-asset class. Here, one can choose from Equity-Linked Savings Scheme (ELSS) of mutual funds and the Unit-Linked Insurance Plan (ULIP), including pension plans and the NPS.
Tenure
All the above tax-saving instruments are medium to long-term products in nature – ELSS come with three-year lock-ins while PPFs come with a 15-year lock-in.
Taxability of interest
Another important factor to consider is the post-tax return of the tax-saving investment. For instance, most fixed and assured returns products such as NSC provide you with Section 80C benefits but the returns, currently 7.6% (five-year) annually, are taxable. This makes the effective post-tax return equal to 5.32% for the highest taxpayers.
Considering an annual inflation rate of 6%, the real return, in this case, is almost zero! Inflation erodes the purchasing power of money, especially over the long term.
Of all the tax-saving tools, only PPF, EPF, ELSS, NPS and insurance plans enjoy the EEE status, i.e., the investment is tax-exempt during the three stages of investing, growth and withdrawal.
Making the right choice
First, identify a goal, medium or long-term. If you need funds in the near future, opt for a fixed income instrument. An equity-backed tax-saving instrument would suit long-term goals as equities need time to perform.
Ideally, try to opt for a tax-free investment. And, before considering a taxable investment, see the tax rate that applies to you and consider the post-tax return. A low post-tax return after adjusting for inflation will not help you in achieving your goals in the long run.
Related: What are tax-free bonds and how do they work
Conclusion
Efficient tax planning should ideally begin at the start of every financial year. Remember, the risks of planning tax-saving in a hurry later are manifold. There is, for instance, a high probability of picking up an unsuitable product, not investing according to the goals and miscalculating tax benefits.
Also, it is important to remember that there is no one instrument that can help you save tax and at the same time also provide safe, assured and the highest returns.
Your final choice should ideally be based on a gamut of factors rather than solely being driven by returns from the financial product.
