Prasun Bhowmik's savoir faire on tax planning would make you think he has been in the business of paying tax for many years. He favours a mix of Ulips, ELSS and Provident Fund to claim the Rs 1-lakh exemption. The investments are aligned to the overall asset allocation of his portfolio. "An 80:20 equity to debt ratio suits my risk-taking capacity," he explains.
Bhowmik is on the mark, but he hasn't developed this strategy from experience. A technical consultant based in Mumbai, he is only 24 years old and has been working for just two years. Unfortunately, such an informed approach to tax planning is not a trademark of his peers.
However, some of them are forced to increase their awareness because of high starting salaries. Bhowmik, who earns about Rs 6 lakh a year, says, "The moment I knew what my salary was going to be, I realised the importance of analysing the various tax-saving options."
Even if the instruments that qualify for the Rs 1-lakh exemption are well known, the modus operandi of tax payments confuses many youngsters. The first problem is the tax deducted at source (TDS). Should you file your returns or worry about tax even if it is deducted by your employer?
The answer is yes to both, especially as you may earn from other investments that are not known to the company. Even if this is not so, experts suggest that you file an income-tax return to maintain order in your own financial books.
HOW SIPs WORK BETTER THAN LUMP-SUM INVESTING | |||
|---|---|---|---|
| 3 Yrs | 5 Yrs | 10 Yrs | |
| Rs 5,000 every month | 2,15,384 | 4,08,348 | 11,50,193 |
| Rs 30,000 every 6 months | 2,09,260 | 3,95,424 | 11,03,568 |
| Rs 60,000 as lump sum* | 2,02,464 | 3,81,171 | 10,52,924 |
*Once every year, assuming a growth rate of 12% p.a. | |||
Though Bhowmik aligns his tax investments with his financial plan, young earners falter in this area too. They invest heavily in equities to exploit the age of high risk, but when it comes to tax planning, they rely on traditional insurance policies and five-year fixed deposits. Equities should be the staple diet of young professionals. So for saving tax, equity-linked saving schemes should be the first choice. The threeyear lock-in period is just right—not too long, in case you want to withdraw the money for higher education, marriage or other goals. Says Naresh Pachisia, managing director of SKP Securities: "People under the age of 30 are likely to have a longterm horizon for the chunk of their investments. So an ELSS makes good financial sense."
Hyderabad-based Pranav Kondejkar, 22, disagrees. He invests in equity instruments for saving tax, but prefers Ulips over ELSS to curb the temptation of withdrawing his investments. Kondejkar pays a premium of Rs 70,000 for three Ulips that offer him a total cover of Rs 3.5 lakh. The balance Rs 30,000 of the Rs 1-lakh exemption is met by his provident fund account. His reason to choose Ulips is not convincing— withdrawals before three years from tax-saving funds also attract a penalty. But you can follow Kondejkar's strategy if you can optimise the benefits of Ulips such as free switches between equity and debt asset classes.
In fact, insurance should constitute a small portion of your taxsaving investments. Pachisia says that several young professionals contribute to their family pool or are responsible for the medical expenses of the elderly in their family. So even though technically they do not have dependants, they may not be completely free of responsibilities. The premium for this insurance policy can make up a tiny portion of the Rs 1-lakh exemption.
Choose term plans over endowment and money-back policies as the latter are more expensive. But if the premium is the mainstay of your tax planning, something is definitely wrong with your portfolio—you don't invest enough.
So the bottom line is to binge on ELSS or equity-oriented Ulips, right? Wrong. Some debt cushion is essential to balance the risk. But don't run after five-year fixeddeposits and National Saving Certificates. Your provident fund is well qualified to do the job. In the long run, it will prove indispensable to your retirement plan too.
These days companies allow employees to rejig their salary structures. Do not be tempted by a high take-home salary to reduce your provident fund contribution. Get your financial priorities right and make sure that tax planning is among the top five.
Case Study
Pranav Kondejkar, 22, Hyderabad
A software engineer, he has invested in the equity option of Ulips on the advice of his friends and an agent.
Income: Rs 48,000 per month
Current asset allocation: His portfolio is rightly biased towards equities that give the best returns in the long term
Debt: 20 per cent, Equities: 80 per cent
| His tax plan for 2008-9 | ||
|---|---|---|
| Section 80C | His investments (Rs) | Our suggestion (Rs) |
| PF | 30,000 | 30,000 |
| ELSS | Nil | Nil |
| Ulip | 70,000 | 70,000 |
| Insurance | Nil | Nil |
| Pension plan | Nil | Nil |
| Total | 1,00,000 | 1,00,000 |
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