After the announcement of the interim budget Mr Piyush Goyal presented, many people were elated about the proposed tax reforms; particularly the full tax rebate for individual taxpayers with taxable annual income of up to Rs 5 lakh.
The new reforms will help you save more, and this can be invested in your long-term financial wellbeing.
But you can enjoy the benefits if tax planning is done at the beginning of the financial year. If you procrastinate till the last minute, you will make ad hoc investments which will be merely a tax saving exercise.
In the month of February, Anand had received a text from the Income Tax department to file his ITR before the last date. If he didn’t, he would have had to pay higher taxes. So, he began his search to choose an investment product to get a tax exemption, but he was indecisive.
Meanwhile, an insurance agent called him with a pitch for an endowment scheme that had a money-back benefit with additional bonus and a reversionary bonus.
Since he wanted to pay lower taxes, he didn’t bother asking relevant questions nor calculating the actual returns that he would get back after the policy term ends. He invested in that endowment plan to save tax for that year. Two years later he realised the blunder he had done.
For an endowment policy term of 20 years, Anand was paying a monthly premium of Rs 2,000. He compared the returns he would get with Equity Linked Savings Scheme (ELSS) for a period of 2 years and 20 years.
Table 1: Insurance returns v/s ELSS returns
|Investment tenure||2 years||20 years|
|Monthly investment (Rs)||2,000||2,000|
|Endowment plan returns at 5% (Rs)||50,582||825,493|
|ELSS returns at 10% (Rs)||53,335||1,531,394|
|Difference in returns (Rs)||2,753||705,901|
The only way he could correct his mistake is to book losses for the first two years and then for the remaining tenure of 18 years invest in ELSS, to earn Rs 385,643 more than what he would get if he held onto his endowment policy.
Table 2: ELSS returns after booking losses
|Investment tenure||20 years||18 years|
|Monthly investment (Rs)||2,000||2,000|
|Endowment plan returns at 5% (Rs)||825,493|
|ELSS returns at 10% (Rs)||1,531,394||1,211,136|
|Difference in returns (Rs)||705,901||385,643|
I have come across several people like Anand, who take action at the nth hour. They do not evaluate and understand the actual returns against their cash outflow, because they are just fixated on the thought of tax saving before the deadline of the fiscal year-end.
So, how can you prevent yourself from repeating such a mistake?
Engage in tax planning from the beginning of the year!
Tax planning is a broader concept that involves a comprehensive investing exercise to ensure tax efficiency. Tax efficiency is achieved by accounting one’s larger financial plan with respect to an individual’s age, financial goals, ability to take risk and investment horizon (including nearness to financial goals).
By adopting the approach of tax planning, you not only ensure long-term wealth creation, but protect your capital.
Hence, please remember to commence your tax planning exercise as soon as the fiscal year begins complementing it with your overall investment planning exercise.
What happens if you do tax planning at the beginning of the year?
- Reason 1: Power compounding works for you
Tax planning takes into consideration the age factor and investment time horizon.
Consider three friends Suresh (25), Mahesh (30) and Rajesh (35) investing for their retirement at their respective ages.
Table 3: Amount 3 friends will receive at retirement Particulars Suresh Mahesh Rajesh Present age (years) 25 30 35 Retirement age (years) 60 60 60 Investment tenure (years) 35 30 25 Monthly investment (Rs) 7,000 7,000 7,000 Assumed returns per annum 10% 10% 10% Sum accumulated (Rs) 2,67,97,937 1,59,55,277 93,65,232 (For illustration purpose only)
From the table above, it is evident that Suresh who starts investing early in an ELSS /Tax saving mutual fund will get Rs 2.67 crore at an assumed rate of return of 10% when he retires. This amount is the biggest than the amounts which Mahesh or Rajesh will receive.
Suresh has many years to retire. Hence with the power of compounding, his corpus will be larger.
So be the early bird who catches a bigger worm!
- Reason 2: Have time to choose investment products appropriately
You have time to choose the right mix of investment products that are suitable for your financial plan and avail maximum tax savings. There are several investment avenues that offer tax exemptions under Section 80 that not only provide deductions but can boost your tax savings too.
Table 4: Snapshot of deduction Section Quick Description of Deduction Deduction limit 80C* Key investment instruments eligible for deduction under this Section include – Equity Linked Savings Scheme (ELSS), Public Provident Fund (PPF), EPF(Employee Provident Fund), NSC (National Saving Certificate), Senior Citizen Savings Scheme (SCSS), 5-year tax saving bank fixed deposits, 5-year Post Office Time Deposit (POTD) , premium paid for life insurance plans, housing loan principal repayment, etc. A maximum of Rs 1.50 lakh p.a. 80CCC* Contribution to Pension Fund of Life Insurance Corporation or any other insurer referred in section 10(23AAB). A maximum of Rs 1.50 lakh p.a. 80CCD* Contribution to Pension Scheme (National Pension Scheme) notified by Central Government. Rs 1.50 lakh p.a. + vide sub-section 1B an additional deduction of up to Rs.50,000 is allowed for contribution towards NPS by the employee. If the employer has contributed to the NPS on behalf of the employer, under Section 80CCD (2) the deduction eligible is: 10% of the salary of an individual. 80CCG The investment made in Rajiv Gandhi Equity Savings Scheme (RGESS) 50% of the amount invested 80D Premium paid for medical insurance Maximum up to Rs 25,000 for non-senior citizens and Rs 30,000 in case of a senior citizen. 80DD Maintenance including medical treatment of a handicapped dependent who is a person with a disability Rs 75,000, irrespective of the amount incurred or deposited. However, in case of disability of more than 80% a higher deduction of flat Rs 1.25 lakh shall be allowed. 80DDB Expenditure incurred in respect of medical treatment Actual incurred, with a ceiling of up to Rs 40,000 or Rs 60,000 in case of a senior citizen, whichever is lower. But for those with age 80 and above, classified as very senior citizens, the eligible deduction is Rs 80,000 80E Repayment of loan taken for pursuing higher education The maximum deduction for interest paid for a maximum of 8 years or till such interest is paid, whichever is earlier 80G Donations to certain funds and charitable institutions Maximum deductions allowed can be 50% or 100% of the donation, subject to the stated limits as provided under this section 80GG Rent paid in respect of property occupied for residential use Maximum deduction allowed is least of the following: Rs 2,000 per month; 25% of total income; Excess of rent paid over 10% of total income 80GGA Certain donations for scientific research or rural development 80GGC The contribution made to any political parties or an electoral trust Amount donated to a political party is fully exempt 80TTA Deduction in respect of interest earned on savings bank deposits A maximum of Rs 10,000 or actual interest, whichever is lower 80U A person suffering from a specified disability(s) Rs 75,000, irrespective of the amount incurred or deposited. However, in case of disability of more than 80% a higher deduction of flat Rs 1.25 lakh is allowed. *The deduction limit is up to Rs.1.5 lakh aggregated across section 80C , 80CCC, 80CCD(1)
(Source: Personal FN Research)
While planning for your taxes, you can consider investing in various avenues as per your risk profile and will increase your tax savings. Basically, you will save more and pay less.
- Reason 3: Optimally use your allowances
You get an opportunity to avail of several salary allowances that can benefit you. Every year the tax rules change, so when you file your returns early, you may get ideas on how you can save tax better for the current financial year. Taking note of these allowances and the impact on your tax outflows will help you optimise your financial budget.
- Reason 4: Can control your tax outgo
If you are a salaried professional, most companies deduct tax in the last quarter of the year. After accounting for all deductions, if the tax is payable, this will be deducted from your salary. Therefore, it is important to work out the tax payable in advance, after availing of all the eligible tax rebates. If there is a high tax outgo, ask your employer to deduct the tax on a monthly basis from your salary.
- Reason 5: Be aware of your monthly investment requirements
When planning your taxes, you can calculate the monthly investment needed. This will avoid a huge lump sum outflow at the end of the financial year. Especially, when investing in a tax-saving mutual fund, it is pertinent that you invest in a staggered manner as opposed to a one-time investment. Besides, you can earn higher returns.
There is no time like the beginning of the year to plan for your tax savings. Last minute tax planning can lead to lower savings and bad investments. It is important for you to know the various routes to save tax on your income. You need to check if you are on the right track towards saving on taxes and take timely action in case you have missed any benefits.
If you are looking at the ways you can save your hard earned money from the tax-man legally, and reduce the tax burden efficiently, PersonalFN’s Comprehensive Guide to Tax Planning (2019 Edition)may be of help. This Comprehensive Guide to Tax Planning is absolutely FREE.
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Author: Aditi Murkute
This article first appeared on PersonalFN here
PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.