Now that the frenzy of investments for tax planning under section 80C and other sections is behind us, it is time to ensure you make the right choice for the next financial year. Remember that investing is the main activity, while tax saving is just one of the outcomes. There are real risks if you make tax savings your goal. Often they surface in long lock-ins, poor returns, higher tax on realised returns and buying products that are not relevant to you.
Additionally, every investor has different financial goals. To achieve them in the most optimal manner, they need to strategise accordingly. To put things into perspective – both tax planning and goal-setting are critical pillars of robust long-term financial planning and you can’t achieve one without the other.
What are they?
Goal-setting is an unremitting process of identifying various short, medium and long-term goals by way of structured and defined plans. This can be done by managing finances and linking each goal to appropriate investment vehicles.
On the other hand, tax planning is a means of maximising disposable income or return on aforementioned investments by taking advantage of the various tax deductions, exemptions and exclusions awarded under the Income Tax Act.
But, which comes first?
Let’s just say when it comes to financial planning, it is a lot easier to plan the journey once you have the destination in mind.
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Optimise investments while saving taxes
Whether your goal is to save for a car, house or a comfortable retirement, it is important to choose the right mix of investments that help you get to your desired goals, while using the benefits available to reduce your overall tax burden.
Section 80C, for example, can help you reduce your taxable income by Rs 1.5 lakh in a financial year in lieu of investments made in ELSS, PPF, ULIPs, tax saving deposits, life insurance plans, NSC, etc.
On account of lower lock-in tenures and possibility of higher gains owing to equity exposure, investment products such as ELSS, ULIPs, etc. tend to be the most preferred tax saving options.
Investors need to look over and above the popular investment choices. You could reduce your tax liability by another Rs 50,000 each year by way of investments in the National Pension Scheme (NPS) under Section 80CCD(1B). In addition to tax savings, the NPS is a great tool to save up for retirement. Thanks to the power of compounding, at an average yield of 12%, an allocation of Rs 5000 per month to the investment for a period of 30 years will give you a corpus of Rs 1.76 crores at the time of retirement!
Also read: Seven money moves to make as a new financial year begins
Let your needs drive your investment decisions
The prospects of high returns or tax savings should not be the only driving factors. Sometimes, our needs necessitate an investment decision that is in the best interest of the family’s long-term goals.
For example, health and safety of family members is a priority for all of us, including parents and in-laws. Due to age-related degenerative issues and other pre-existing conditions, buying health insurance for older members in the family is imperative. One can invest in a mediclaim policy or a family floater plan.
Paying for healthcare expenses out of your pocket can drain your savings and have an adverse impact on your ability to meet other financial goals. In this scenario, the ‘value’ of health insurance as a risk management tool far exceeds its ‘cost’. Not only does the insurance cover offer protection against spiraling medical and hospitalisation costs, it also ensures your loved ones can get the best healthcare services as and when they may need it.
Additionally, premiums paid towards health insurance of dependent parents/ in-laws is a tax deductible expense under Section 80D. You can claim up to Rs 25,000 (for parents below the age of 60) or Rs 50,000 (for parents above the age of 60), in addition to Rs 25,000 for health insurance expenses for self, spouse and dependent children. Thus, making it possible to claim anywhere between Rs 50,000 to Rs 75,000 on health insurance expenses.
Take a systematic approach to investing
Many of us wait until the last moment to invest. It is prudent to spread your investments throughout the year. ELSS and NPS funds allow SIPs, while most other products let you invest throughout the year as well. It is important to take advantage of cost averaging if you are investing in equity linked products. Even if you are investing in fixed return instruments, it makes sense to invest throughout the year so that there is no pressure of a large outflow at the end of the financial year.
Take advantage of tax break where available
Sometimes tax compensations present meaningful savings opportunities. If you have long-term capital losses through sale of equity shares or mutual funds, you can offset those losses against taxable long-term gains from similar assets, provided taxes were filed in the loss making year.
Self-employed professionals and entrepreneurs looking to buy a car (and utilise it for legitimate business purposes) can claim depreciation on the asset to reduce their taxable income. The rate of depreciation is 15% for cars purchased before September 30 and 7.5% for those purchased after.
So if you purchased a car worth Rs 10 lakh, your annual tax liability can be abridged by an additional Rs 1.5 lakh. Additionally, the interest paid towards such a vehicle loan can also be claimed as a business expense to offset your overall income.
Other tax deductions such as interest on home loan (Section 24), rent in lieu of HRA (Section 80GG), donations (Section 80G), etc. are other popular avenues of reducing your tax liability.
In closing
The two are complementary strategies. Tax planning without goal-setting could result in inefficient investment allocation. While goal-setting without tax planning will not allow you to maximise the yield on your investments on account of gains negated by taxes. Do keep in mind that you are investing in your financial future. It is important to start early, plan your investments and then invest throughout the year. There are various avenues available for tax planning. Know your deductions for various investments, health insurance, pension plans, loan deductions and charitable donations. Take help from an expert if you think you need it.
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