With the fiscal year-end nearing, it is time to put your tax saving plan in place to avoid last-minute panic.
Now that we are in the second half of the financial year, it's as good a time as any to begin one’s tax planning. Most people approach their investments with the sole objective of saving tax for the current year. As long as investing in the chosen instrument results in getting the tax deduction, their immediate purpose is solved. The instrument of choice is, more often than not, based on colleagues' recommendation or a flavour of the season, promoted heavily in the media. The result is you end up saving taxes. However, there is very little or no planning.
For instance, consider Section 80C, the only meaningful deduction left. Under this section, any investment up to Rs 1 lakh made in certain specified instruments can be deducted from your taxable income. There is a long list of eligible investments, including contribution towards Employee Provident Fund (EPF) tuition fees paid for children, the principal portion of housing loan equated monthly instalments (EMIs), investments made in the Public Provident Fund (PPF), Equity-Linked Saving Schemes (ELSS), National Savings Certificates (NSC), Senior Citizen Savings Scheme, Post Office Term Deposits and life insurance premiums paid among others.
These are investments that one usually makes by default and therefore, are no different than one’s regular investments. All you need to ensure is that these are integrated into the larger picture, in line with your risk profile and financial goals.
USING SECTION 80C OPTIMALLY
So, how should an investor choose from amongst the various choices available? Here’s what you should do.
First, take into account mandatory payments like EPF contribution, housing loan EMIs and tuition fees, if applicable. Reduce the total amount spent from the Rs 1 lakh limit. Distribute the balance in a combination of ELSS and PPF. If you are relatively young and just starting out, put 70 per cent into ELSS and 30 per cent into PPF. As you advance, lower the ELSS and increase the PPF, eventually reaching a 30 per cent ELSS and 70 per cent PPF combination.
Why PPF? It is the best fixed income investment you can make. An annual contribution of Rs 70,000 will get you around Rs 32 lakh in 20 years. Look at it as a fund for the education needs of your children. If your children don’t need it, get your spouse to invest, too, and you would have a retirement fund ready.
An ELSS is nothing but an equity mutual fund that offers a tax deduction. On account of the tax deduction, a lock-in period of three years is applicable on the investment. This lock-in enables the fund manager to take long-term calls on the market, essential for equity investments. ELSS investments are the most preferred way to build long-term wealth. However, this investment comes with the inherent risk of the stock market. Hence the suggestion that the proportion of ELSS in your total tax saving investments should decrease as your age advances and the risk-taking ability declines.
Take the case of Amit, a web designer by profession. His grouse: he had over Rs 5 lakh in receivables but many clients were holding out for higher credit periods. Since income is taxed on accrual and not on receipt as per our laws, he has to pay tax on the amount of Rs 5 lakh, not yet received. He was finding difficulty in arranging the funds required to pay his employees for the month, so to keep anything aside for tax saving was a long shot.
In such cases, one can use another tax planning tool. We call it recycling. Amit can simply withdraw an earlier investment (say from ELSS) and redeposit the funds, even in the very same instrument. He will get the tax deduction for no additional outlay. In other words, his savings remain the same. All, without investing a single extra rupee plus availing of the 31 per cent tax saving.
As mentioned earlier, your tax saving investments are no different from your regular ones. So, the basic principles of investing remain in both cases. Therefore, this year, instead of waiting till the end, start by investing in tax-saving avenues as early as possible. This has a two-fold advantage. First, these investments would earn a return from the time you make the investment. Second, at the last moment, you may not have the lumpsum funds needed for 100 per cent tax saving.
It is not compulsory to make tax-saving investments only towards the end of the year. Instead, invest towards the goal throughout the the year in a staggered manner. So that, when the year comes to an end, you would have taken full advantage of the tax saving opportunity. And, don’t worry about how much or how little you save each month. As Benjamin Franklin has so succinctly put, “A penny saved is a dollar earned!”
The writer is director, Wonderland Consultants