Investing to save tax is something that most of us consider easy-to-do. Ask Alli Raja, a 32 year-old software engineer who has been doing it since he was 25. In seven years of active investment, he has lost both opportunity and money by not aligning his tax planning with his financial planning. Raja’s tax saving investment has little or nothing to do with his long-term financial needs.
He has picked three money back insurance policies with roughly Rs 40,000 annual premium, predominantly for tax saving. The policies mature in 20 years and the life cover is only for Rs 8 lakh. Too little for a father of two. He chose NSCs to invest Rs 1.5 lakh in secure instruments that start to mature from March this year. Raja is unaware that the interest from these is taxable as well. The only thing that is going well for him is the housing loan he had taken four years ago. The property has appreciated in value and the tax benefits are sizeable. The problem with such a portfolio is that there are no financial goals except tax planning. All other benefits are considered as bonus.
Tax-saving investment is only a part of the larger spectrum of financial planning. It is best to invest with the aim of realising short and long-term financial goals keeping in mind the tax benefits. Understand your medium- and long-term needs and the products that are available for tax saving. Choose a product which you need and not the one which is easily available or sold in the most attractive way. Says Jayant Pai, vicepresident, Institutional Equity Sales, Parag Parikh Financial Advisory Services, “Tax laws are beyond you, they are tinkered every year by the government of the day. Whereas your need is specific, at best you can take benefits of the external (tax) changes to suit your financial needs.”
Thankfully the new expanded Section 80C allows a better match between tax planning and financial planning. It offers a wide range of term and liquidity options—ranging from pure debt to pure equity (see box Section 80C Menu). Also, it is not restrictive, barring the Rs 70,000 cap on PPF investment. One can opt for any product to maximise the Rs 1 lakh investment to get the tax deduction.
Insure yourself first. It is the base of your financial pyramid and should be rock solid. Of course, by insurance we mean term life insurance, and not the investment and savings- linked products. Life insurance costs go up as you age and is very high in your best earning years (30-50 years). It is best to take policies that mature as late as possible.
Financial planners suggest that for most individuals in early earning years, tax rebates will work best if the asset allocation is equityheavy. “It’s advisable to start with a 40:60 debt-equity ratio when you are under 30 years old. The power of compounding works best when you start early. So even a small amount going towards an equity instrument can add up substantially to your retirement corpus than starting late with large amounts,” says Bangalore-based planner B. Srinivasan.
|SECTION 80C MENU|
|Age Insurance PPF/EPF NSC Pension ELSS|
|Under30 10,000 20,000 10,000 15,000 45,000|
|31-40 15,000 20,000 10,000 15,000 40,000|
|41-50 15,000 15,000 15,000 15,000 35,000|
|51-60 10,000 15,000 35,000 10,000 30,000|
In either case, by retirement, your portfolio should have a debt to equity ratio of 60:40. Such an asset allocation gives you a cushion of regular payments from the fixedreturn instruments in case your pension plans go awry. NSCs are the preferred debt instruments as you age simply because of the psychological security that your money is not locked in for very long and does come back to you at six year intervals. By this time, the 15-year tenure of your PPF is also through, so you can dig in those funds if required.
"There is no right time to invest; it is the time you give to your investments that matters"-JAYANT PAI, VICE-PRESIDENT, Parag Parikh
Investing early in property is also a good investment strategy. Not only do you build an asset for yourself, there are tax incentives that help you offset the loan liability. Of course, one should never go in for a longer housing loan just to save taxes. Remember that on 15-20 year housing loans, you end up paying a huge sum as interest.
| "Compounding works best when you start early. Even a small amount can add to your retirement corpus"-B. SRINIVASAN, Financial Planner|
Invest for a bright today and a secure tomorrow. And don’t let the Rs 1 lakh limit stop you from investing more. To tweak an old saying: The more the better.