Taxing times: Make an early start on tax planning

Maintain asset allocation and invest based on risk profile

Last Updated : Apr 01 2017 | 11:36 PM IST

The financial year has come to an end and with it the last-minute running around to make tax-related investments. From November onwards, accounts department of companies put employees through the wringer, first asking them to declare their tax-saving investments, and subsequently requiring proof of these investments. Employees who procrastinate and leave their tax investments for the last three-four months of a financial year find themselves under a lot of financial pressure. All that can be avoided if you begin planning right at the beginning of the financial year.

Keep goals in mind: While tax saving is important, investments made for this purpose should also help you move closer to your financial goals. In other words, your tax planning should dovetail with your financial planning. Hence, before investing in a tax-saving product, ask yourself the following questions: Which of your financial goals will this instrument help fulfil? Does it fit into the asset allocation that is ideal for you, based on risk appetite and investment horizon? Does the lock-in period suit or cause a liquidity crunch? Is the risk-reward balance favourable in this instrument?

Your age and risk profile should play a crucial role in determining your choice of instrument. Someone aged 35 and having an aggressive profile could have an asset allocation of 75 per cent to equities and 25 per cent to debt in his retirement portfolio. He might invest in equity-linked saving scheme (ELSS) funds and the national pension system (NPS, with high equity allocation) for his equity portion and in public provident fund (PPF) for the debt portion. PPF is more tax-efficient than national savings certificate (NSC) and five-year bank FDs.

On the other hand, someone approaching retirement might have a 75 per cent allocation to debt. For such an individual, investments in employees’ provident fund (EPF) and PPF might not be sufficient. To meet higher debt allocation, one might also have to invest in the NPS (with high debt allocation), tax-saving FDs and so on.

Instruments like PPF and NPS lend themselves well to long-term goals like retirement, children’s education, children’s marriage, etc.

Keep risk appetite in mind: ELSS, which qualify for Section 80C deduction, are suitable for persons who can bear the volatility of equities. They also have the shortest lock-in (a mere three years) period among all tax-saving instruments. To reap the growth advantage of equities, leave the money invested in the ELSS fund even after the lock-in ends.

For someone with a low risk appetite and a long investment horizon, PPF is a good choice. Its tenure is 15 years. For those tranches of your money that are invested later in the tenure of PPF, the lock-in period is less than 15 years. Unlike other long-term retirement products like NPS, which gets an exempt-exempt-tax treatment (taxable at maturity), PPF enjoys tax exemption at all three stages. One risk in PPF arises from the fact that the interest rate on it is revised every quarter. If these rates witness a decline over the long period, returns from PPF could be affected.

Choose the right instrument: Several other instruments qualify for tax deduction under Section 80C. Some of them are NPS contributions, life insurance premiums, NSC, five-year bank FDs and so on.

Each of these products has different features. NPS is a long-term product. The underlying investment in it can be either equities or debt. At the time of retirement, 40 per cent of withdrawal is tax-free, and at least 40 per cent must be annunitised. While NPS is a low-cost product (fund management charges are extremely low), many people find the tax on final corpus and the compulsory annuitisation irksome. If you too think so, limit your investment in NPS to avail of the Rs 50,000 deduction under Section 80CCD(1B).

Life insurance is another long-term product that qualifies for Section 80C benefit. The maturity proceeds are also tax-free. It is also a product that is mis-sold the most during the tax season, and the one where people mostly go wrong. Once a wrong decision is made, it is difficult to solve. If you invest in a traditional product, you might find that the insurance cover you get is inadequate and the return is low (as these products invest mostly in debt paper). Unit-linked insurance plans or Ulips are better products now after the regulator reduced the charges insurance companies can levy. However, they come with a five-year lock-in. If a Ulip’s fund underperforms, you can only shift from one fund of the same insurer to another. If you are investing in an insurance product, go with a term plan and you cannot go wrong. However, you will have to ask for this product. It is not one that insurance agents will sell to you.

Under Section 80D, you can avail of tax deduction on premium paid on health insurance. Given the already high cost of medical treatment and high medical inflation, buying health insurance has become critical, especially if you live in a metro, where treatment costs tend to be higher. Premiums paid for these policies up to Rs 25,000 can be claimed as deduction under Section 80D. Another Rs 25,000 can be claimed if you pay premium for your parents’ cover (Rs 30,000 if they are senior citizens). Buy a personal health cover even if your company provides you one. When you move from one job to another, the next company may not have as good a health cover. Later in life, if you decide to become an entrepreneur, the personal cover would come handy. At that age you might find it difficult to get a policy.

While investing for tax saving is important, it should not become an end-goal but help you move closer to your financial goals. Starting early will allow you to take well thought out decisions in this matter.

If you are an early bird, you can…