It's a sad fact that when it comes to finances other than their own, almost everyone is an expert. And that's why, come tax time, you'll hear gems like "increase the tenure of your home loan to make the most of the tax breaks available".
Gullible or harassed taxpayers who have not planned their taxes end up taking advice like this. And they later find that they've paid almost double the loan amount as interest. Or you might decide to buy an insurance policy simply for the Section 80C benefits, although you are already adequately insured and might not be able to pay the extra premium the following year.
Advice like this could get you into more trouble than you ever anticipated. The trick is to incorporate tax planning with your financial plan, instead of treating it as an independent entity that has nothing to do with your monthly or annual budget. Also, it's important to realise that although you might have chosen the right instruments to save taxes, you can save a far sight more if you use these instruments wisely.
So, how can you start planning your taxes without taking well-intentioned but practically useless words of w i s d o m from so-called experts? We present some strategies that will let you make the most of the tax breaks available, and which will fit well into your existing financial plan.
1. Stagger investments
|Number of units|
|Total investment: Rs 30,000, Total number of units: 1506.4 Average price per unit: Rs 19.92|
Beware the rush of March. Almost all of us wait till January, when offices generally send out a notice asking for details of tax-saving investments. And then we try to squeeze the year's tax savings into three months, which is invariably a huge drain on any budget. And so, for three months, it's farewell to luxuries and indulgences and welcome to an ascetic life.
If, however, like the ant in the fable, you invest regularly throughout the year, you will not only have a better grip on your finances, your investments will be larger.
If you invest Rs 5,000 a month in a tax saving mutual fund (which earns 12% a year) instead of Rs 60,000 in three tranches in January, February and March, your investment would be bigger by about Rs 2,700 at the end of the year.
The way to disciplined investing, possibly in an equity-linked savings scheme (ELSS), is through a systematic investment plan or SIP.
2. Make affordable annual commitments
Insurance salesmen and agents can be very persuasive. And when they come to you in February, telling you how much tax you will save by buying an insurance or a pension product, chances are that you'll leap at the opportunity.
But resist the temptation to sign a cheque immediately and ask yourself if you really need the product. If you don't need it, but are still willing to buy it for the tax advantage, check your finances and your budget to see if you can afford to sustain this investment. For instance, you might take a pension plan for Rs 10,000 in order to save Rs 3,000 on tax.
Can you afford Rs 10,000 next year and the year after and so on? Products like insurance are long term in nature and you cannot take it just for a single year. Make sure you can sustain your investment before you decide on long-term tax saving plans.
3. Buy insurance only if you need it
Yes, you get tax benefits under Section 80C on premiums paid towards life insurance policies. And under 80D on premiums paid on health insurance plans. But if you are already adequately insured, insurance is not the ideal tax-savings tool.
Sadly, most taxpayers look at insurance as a tax saving tool first and as death cover only later. If you are under-insured, it's a good idea to buy insurance even if you buy it for all the wrong reasons. After all, the real point of insurance is to protect your financial dependents in case of your untimely death. Calling it a tax savings scheme does not take away from that underlying premise.
It's pretty much the same in case of health insurance, where you can claim benefits under Section 80D. Yes, health insurance is necessary for everyone, but if you already have enough, or if you cannot afford the regular premiums, it makes little sense to take it and suspend it in the space of a year or two.
4. Understand post tax yield
|Investment (Rs)||1 lakh||1 lakh||1 lakh||1 lakh|
|Pre-tax yield (%)||9||10||8||9|
|Pre-tax income (Rs)||9,000||10,000||8,000||9,000|
|Tax rate (%)||30||30||30||10*|
|Net income (Rs)||6,300||7,000||5,600||8,100|
|Post-tax yield (%)||6.3||7||5.6||8.1|
|*If redeemed within a year; tax calculation does not include 3% education cess|
Assume you have the option of investing Rs 10,000 in one of two schemes: one that gives you 10% returns and one that gives you 7%. Obviously, the 10% scheme seems more attractive.
But if the scheme offering less is actually offering you 7% tax free returns, what should you choose? Till two years ago, up to Rs 12,000 a year earned as interest was exempt from tax under Section 80L.
When this section was scrapped, interest earned on instruments like NSCs and bank fixed deposits were clubbed with annual income and the whole was taxed. So, when doing your tax planning, don't get lured by higher returns on an investment; understand the tax implications on them.
Look at options like the public provident fund or PPF, where the interest income is not taxed, or at Ulips and tax-planning mutual funds, where profits are tax free.
5. Look at the big picture
A long-term debt plan might not be on top of any financial planner's recommendations. However, you can make the most of a long-term debt instrument like the PPF by taking full advantage of the withdrawal option it offers.
After year 7 or 8, withdraw the maximum tax-free amount and reinvest in an ELSS or similar instrument. Why ELSS? The chart below explains the advantages of investing in a three-year ELSS over a sixyear National Savings Certificate.
6. Take advantage of dual income
|Click here to read on how and when NSC loses out to ELSS|
Did you know that it actually makes tax sense to be married? Especially if your spouse is in a different tax bracket. If you are a dual income couple encompassing two different tax slabs, make the most of investing for taxes from the income that falls in the higher tax slab.
This allows you to pay a lower rate of tax on the higher income. There’s more. Working couples with a child can contribute Rs 35,000 each every year to max the PPF contribution for their child. The corpus at the end of the 15-year tenure can serve to meet the child’s higher education expenses.