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Tuesday February 3
Source: Indian Express Finance
In sync with financial goals
The Kanodias are a perfect example of how last minute tax planning measures can result in sub-optimal financial planning. Shisir and Dimple Kanodia work for a Gurgaon-based multinational company. As hectic work schedules, family responsibilities and social networking kept them busy, they kept pushing their tax planning decision till the year end. Swayed by the sales spiel of an insurance agent, the Kanodias bought life insurance policies to save tax. During the 24 years of their working life the couple had invested in almost 24 life insurance policies. According to their financial advisor Kartik Varma, "The couple together has over 24 life insurance policies, but is still not adequately insured."
Towards the end of the financial year, a lot of people frantically buy life insurance policies to save tax. "People often keep delaying their tax-planning decisions. Last minute urgencies often lead to buying something that might save tax, but ends up being totally irrelevant when taking into account their life goals," says Varma.
Topics
The right way
Essentially tax planning should be a part of your financial planning, and not an end-goal in itself. And it should be a year-round process.
Calibrate risk and liquidity needs. As the deadline presses near, a lot of people pledge their money to various tax-saving instruments without knowing the risks involved or even the lock-in period. In turn, they compromise on their liquidity needs.
The choice of instrument should ideally depend on your risk appetite and financial goals. "Choose the product based on your risk appetite and liquidity needs," says Veer Sardesai, a Pune-based financial planner. A person who is not averse to risk can invest in an equity-linked savings scheme (ELSS), and enjoy tax free dividends and redemption. On the other hand, a risk-averse person may have to use a longer lock-in by using a National Savings Certificate (NSC), or even Public Provident Fund (PPF). Ideally, you should invest in a mix of these high-risk and low-risk investments.
Link tax planning with financial goals. Tax-saving instruments are usually long-term in nature. Therefore, the investments you make for saving tax should also help you meet your larger financial goals. "Tax planning must be done under the broader purview of the financial plan," says Mumbai-based financial planner Amar Pandit. One can start with PPF, which has a lock-in period of 15 years and offers interest that is tax free.
Pay attention to post-tax returns. Another important point is post-tax returns. While products like the NSC promise 8 per cent rate of return per annum, the interest accrued is taxable, which brings down the post-tax return to a meagre 5.28 per cent. PPF, on the other hand, gives a relatively higher return at 12.12 per cent.
Although debt instruments lend stability and safety to the portfolio, equity exposure is a must if you wish to see your wealth grow over the long term. And this is where ELSS comes into play. The average five-year returns from ELSS works out to 12.25 per cent. On a conservative note, even if we take a modest 10 per cent rate of return, the effective post-tax return works out 15.15 per cent.
Choices available
For the sake of convenience, we have divided various tax savings instruments into the following categories:
Miscellaneous
This category should be given top priority while doing tax planning. "Before zeroing in on tax-saving tools, whether it is life insurance, pension products or others, you must take a note of things like home loan payments, children's tuition fees, education loan, health insurance, etc. All these expenses too are eligible for tax deduction under various sections," says Pandit.
The Income Tax Act also allows rebates on numerous expenses. Some of them are: payment of principal amount of home loan, tuition fees, repayment of education loan, health insurance premium, expenses incurred during treatment of specified diseases, donations, and rent paid for residential purposes (see: What Are The Benefits Available).
After taking into account these expenses, if there is still some room left, look at other tax-saving instruments.
Traditional products
If you are looking for a steady income, then PPF, infrastructure bonds, NSC, and tax saving fixed deposits with banks can serve your purpose. However, do not expect great returns from these instruments. Although these tax savers promise returns in the range of 7.5 per cent to 9 per cent, their real returns are much lower owing to income from them being taxed. All the products have varied lock-in periods and different tax treatment as well (see: How The Different Tax-Saving Tools Measure Up).
Life insurance policies
All premiums paid for life insurance covers are eligible for tax rebates under Section 80C. By far this is the most exploited instrument in tax planning. "Life insurance should not be seen solely as a tax-saving measure; rather tax saving is the icing on the cake. If you have liabilities and dependants, then certainly life insurance should be the top priority," says Pandit.
However, choosing the right insurance policy is important. While unit-linked insurance policies (Ulips) do give the comfort of insurance as well as investment, term plans should be used to take insurance cover. Term insurance gives you a higher cover at a cheaper price. "The objective of buying life insurance is to cover all your liabilities. And this can be done best with a term insurance cover," says Pandit.
Look at two things while buying a term cover: premium and the maximum cover allowed. The plan with the lowest premium is adjudged the best in this category. Also, try and fish for a term plan that gives you the maximum possible cover (see: Life Insurance).
Mutual funds
Among mutual funds, the only category that qualifies for tax rebate is the ELSS. As the name suggests, these products invest in equity markets and have a lock-in of three years. You can start investing in an ELSS with a sum as low as Rs 500.
"Currently equity markets at a low. The long-term reward from equity investing is likely to surpass those from all other assets," says Sardesai. Although ELSS can provide an effective hedge against inflation and help you grow your wealth over the long term, remember that these instruments carry market-related risk that is borne by you. So assess your risk-taking ability before you invest in them. However, a longer investment horizon - of three years or more - helps mitigate this risk.
While saving tax is important, what is more important is achieving your financial goals. Keep both these goals in mind while choosing your tax-saving instruments.
