Come January and a lot of taxpaying individuals suddenly wake up and start looking for tax saving options. This is primarily because of the tax saving proofs that they need to submit to avoid a higher tax deduction at source.
In this rush, people generally end up taking a hasty and myopic view of tax planning as their only agenda is to save tax. I have seen people ending up with a plethora of life insurance policies, pension plans, mutual funds, tax saving deposits and so on.
In the end, most land up with expensive products, low post-tax income and products that they do not even require. However, there is no need to rush through the entire process if one starts off early, typically in the first week of the financial year in April. Yes you read it right. The best time to start off your tax planning exercise would be in the first week of April itself.
Tax planning must always be seen within the broader framework of financial planning. The actual goal of tax planning should be to maximise post-tax income, which typically, is a function of higher returns, lower costs and so on. Most people lower their total taxable income through deductions.
Among the various deductions available, the most common is section 80C with a limit of `1 lakh. Besides this, a `20,000 deduction is available to you if you invest in infrastructure bonds.
However, before you embark on your journey to invest in tax saving products, let’s first understand the basic exemption limits and tax slabs, which vary depending on whether you are an individual male below 65 years, a woman or a senior citizen [65 years and above, irrespective of gender].
The next step is to understand your gross total income. Generally, for most people, there are five sources of income or income heads.
- A. Salary
- B. Income from house property
- C. Profit and gains of business or profession
- D. Capital gains
- E. Income from other sources.
Once you know your income under various heads, you should calculate your gross total income by adding all income heads. Once this is calculated, look at the deductions that you can avail. The most common of the deductions is the one under Section 80C.
Under Section 80C, besides the usual PPF [Public Provident Fund], EPF [Employee Provident Fund], ELSS [Equity Linked Saving Schemes], life insurance and tax saving FDs [Fixed deposits], there are two non-financial investment avenues that you can use: Principal amount of home loan EMI and school and college fees.
If you have taken a home loan or are paying your children’s school fees, you are already doing the above—it means you are already contributing to tax saving instruments under Section 80C.
Calculate how much amount you pay towards your home loan principal or your children’s school fees, annually. Now deduct this from `1 lakh. The difference amount is what you need to invest from a tax saving perspective. However, if you do not have a home loan or pay fees, here is what you can do.
The first choices
Do you need a house? If you do, avail a home loan when buying it. This is the first option that you should exercise, as it gives you a deduction on the principal investment as well as the interest component. However, these are times of inflation and high rates. So don’t rush into buying a house now, if you haven’t yet done so.
Do you have any dependents and liabilities? If the answer to even one is yes, and you are in the accumulation phase [between 25 – 50 years], do your needs analysis and buy adequate life insurance, preferably term insurance.
Let’s say you are a 35-year old male and you take a term insurance for `1 crore for 20 years. Should you die during this period, your nominee/beneficiary will get `1 crore. The annual premium you will have to pay is `30,000 [approximately].
If you want a fixed return investment, then you should first go for PPF and EPF/VPF [Voluntary Provident Fund]. It’s an excellent investment for anyone in the highest tax bracket. Anyone can open a PPF account at the nearest nationalised bank or post office. Although traditional insurance policies, National Savings Certificate [NSC] and 5-year Tax Saving Fixed Deposits also fall into this category, PPF and Senior Citizens Scheme remain the best debt investments so far.
On the equity front, the choice is between Unit Linked Insurance Plans [ULIPs] and ELSS [these are tax saving mutual funds]. Opt for ELSS as they offer better liquidity and performance. They also cost less. You can also look at single premium ULIPs.
When compared with PPF, NSC and traditional insurance plans, the returns from ELSS are the highest. Even though equities provide high returns over the long term, they are a risky asset class. They are prone to volatility and there could be periods of negative returns. However, liquidity is the best in ELSS. Considering that the market is in a corrective phase now, you can look at investing in ELSS on dips.
It is important to know which fund to invest in. And as the choices keep increasing, choosing a fund is getting even more difficult. Look at consistency rather than a one-off performance. Opt for investments with a proven track record in good as well bad times and experienced managers. Additionally, as mentioned above, invest `20,000 in infrastructure bonds.
The trick to investing smartly and boosting returns [at optimal risk levels] lies in investing in a combination of debt, equity and real estate funds to maximise your post-tax income.
Over and above 80C
Besides Section 80C, some of the other deductions that you can avail are:
- a] 80D: Mediclaim premiums paid for yourself, spouse, children and dependent parents.
- b] 80E: Interest on educational loans.
- c] 80G: Donations.
- d] 80U: Deduction in case of a person with disability.
- e] Section 24: Interest up to `1.5 lakh on one self-occupied property.