It is important to plan one’s finances properly. Plans should never be made on an ad-hoc basis or for a temporary goal or towards an ill-conceived objective. By proper tax planning, one not only reduces the tax liability but also end up saving towards the various goals one has set at different life stages.
Choosing the right tax-saving vehicle rests primarily on four things: How to avail tax benefits, the kind of tax-saving instrument, the tenure, and the taxability status. Equally important is to choose a tax-saving instrument which can be linked to a specific goal.
How to avail tax benefits: One may consider Section 80C which allows annual tax benefits of up to Rs 1.5 lakh in one or more eligible investments and specified expenses. The eligible investments include life insurance, equity-linked savings schemes (ELSS) mutual funds, public provident fund (PPF), national savings certificate (NSC), etc., while expenses and outflows can include tuition fees, principal repayment of home loan, among others. If the taxpayers have exhausted their annual limit of Rs 1.5 lakh, they can now look at National Pension System (NPS) to save for their retirement and in the process save additional tax. From 2015-16 onwards, an additional deduction of up to Rs 50,000 is also possible. For someone in the highest 30 per cent income tax bracket, it’s an additional annual saving of about Rs 15,000.
Premium paid towards a health insurance plan for self and family members qualifies for tax benefit under Section 80D for Rs 25,000 and Rs 30,000 for those above 60. 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, interest payments under Section 80E for education loan, etc.
Kind of tax-saving instrument: 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 assets, including notified bank deposits with a minimum period of five years, endowment, PPF, NSC, senior citizens savings scheme (SCSC), etc. The ‘market-linked returns’ category is primarily the equity-asset class. Here, one can choose from ELSS of mutual funds and the unit-linked insurance plan (Ulip), including pension plans and the NPS.
Tenure: All the above tax-saving instruments by nature are medium to long term products – from a three-year lock-in that comes with ELSS to a 15-year lock-in of PPF.
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 8.1 per cent (five-year) annually, are taxable. This makes the effective post-tax return equal to 5.60 per cent for the highest taxpayers. Of all the tax-saving tools, only PPF, EPF, ELSS and insurance plans enjoys the EEE status, i.e., the growth is tax-exempt during the three stages of investing, growth and withdrawal. Considering the annual inflation of six per cent, the real return is almost zero! Inflation erodes the purchasing power of money, especially over long term.
Making the right choice
First, identify a goal, medium or long term. An equity-backed tax-saving instrument would suit long term goals as equities need time to perform. As wealth keeps accumulating over the long term, try 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.
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.
Also, there is no one instrument that can help you save tax and at the same time also provide safe, assured and highest return. Your final choice should ideally be based on a gamut of factors rather than solely being driven by returns from the financial product.