Make tax-saving a part of your overall financial plan
Date Published: February 20, 2023
Arindam is a young salaried professional in the 30% tax bracket who has not put too much thought so far on planning for his taxes. Typically he has ended up buying some NSCs and Infrastructure bonds at the end of the year just to make sure that he uses up the available limits for tax benefits. The last financial year was no exception! Arindam needs some help on what he must consider while making decisions related to tax planning.
This practice of random saving for tax benefits towards the end of the financial year is rampant among individuals. Anything that saves taxes baits us all. There are millions who still buy Ulips with high premiums to save taxes. They refuse to believe it is a long term product and are convinced that if they pay for five years, they will get something in the future. Worse, many sign up for large insurance premium that they struggle to pay. They convince themselves it is a good way to save taxes and also build assets. In a year or two they realise that they cannot pay the premium as it is too high, and then find out that stopping the policy leaves them in losses.
Compulsory saving brings us to the other popular choice—housing loans. Many think the tax concessions on buying property makes it a fantastic investment. They like the ideas of tax saving and owning an asset. What they fail to see is that the money they pay with interest is quite substantial, even after allowing for taxes, and the asset they acquire is very inflexible, indivisible and quite a pain to sell if need arises. When we hear stories of parents selling property to educate their children, we are speaking of those who are pushed to that point, as they have no other asset to fall back on.
Arindam must see the decisions he makes for tax planning as part of his overall financial situation. The investments he is considering must keep the asset allocation suitable to his stage in life in mind. Given his age, his asset allocation should be primarily equity-oriented. The EPF contributions he makes as an employee will be adequate as the debt component in his tax investment portfolio. Further exposure to debt investments, including infrastructure bonds, at this stage will be inefficient given their lower returns even on post-tax basis. His portfolio needs higher return equity- oriented products such as a consistently good performing Equity-linked Savings Schemes (ELSS) of mutual funds and Unit-linked plans (Ulips) of insurance companies. However, Arindam must consider the long-term periodic commitment which Ulips require that he may not be in a position to make this early in his career. The NPS, with equity capped at 75% may also be sensible option for a young investor like him. PPF is a EEE government saving scheme product with a 15-year lock-in, ideal for those looking at a fixed guaranteed return over a long term.
Arindam must set in place a systematic investment plan (NPS, PPF and ELSS allow for the same) so that he gets the benefit of cost averaging in the investments that he makes and he is not under pressure at the end of the year to find the funds for investment. Arindam must also not ignore the tax benefits available on certain expenses incurred by him such as premium on life and health insurance. However, he must consider insurance only to the extent of protection required by him and not as a tax saving tool and must choose a low cost cover. Similarly, rent paid can also be used to reduce his taxes if he is not receiving a house rent allowance from his employer.
While making investments and commitments for tax benefits, Arindam should remember that they all come with a lock-in which will make the funds inaccessible in case he requires money in an emergency. He must make sure that he has some financial cushion before he blocks his money in tax planning investments. Every rupee should serve his financial goals. He must not stash money away in low return investments and poor quality assets just to save tax. If he is only goaded by tax saving, he will end up with investments and assets he doesn’t need or won’t use.
If what we like and need also comes with some tax saving, that is a good thing. But directing all investment decisions with an eye on taxes alone, can end up badly like an eyesore. Further, starting tax planning process in the early part of the financial year will not only helps Arindam align his investments with his financial goals but also allows him to comfortably utilise all the deductions and save maximum tax possible.