What is Tax Planning?
Taxes have the potential to eat into your savings. To counter this, tax planning is an authentic way of decreasing your tax liabilities in any financial year. Adopting tax planning practices helps you utilise the tax deductions, exemptions, and benefits provided by the authorities in the most optimum way to minimise your tax liability.
The definition of tax planning is very simple. It is the complete analysis of one’s financial condition from the tax efficiency point-of-view.
Tips for better tax planning
Following are some of the tips that can be adopted by all investors, old and new, for better tax planning:
- Understand your taxable income before you begin tax planning
The most common misunderstanding among investors is assuming that the CTC (cost to the company) is same as the taxable income. However, this is not true. There are various deductions available that can significantly lower the taxable income. Some common deductions include home loan, house rent allowance (HRA), education loan, premium paid for medical insurance, several tax-saving investments such as ELSS (equity-linked savings schemes), NPS (national pension scheme), SCSS (senior citizens savings scheme), etc.
- Understand the amount you need to save and ultimately invest
Understand the sum you need to save to fully utilise Section 80C Section 80C offer tax deductions for investments of up to Rs 1.5 lac. Common investments included under Section 80C deductions are ELSS mutual funds, NPS, EPF (employee provident fund), PPF (public provident fund), etc. An investor can save up to Rs 46,800 by investing in these instruments.
- Create an emergency fund
Analyse how much emergency funds you own. One should typically have an emergency fund of at least three to six months of their expenses. These funds should be invested in instruments that are readily accessible at dire times. These instruments offer higher returns than a traditional savings account and also have high liquidity.
- Make regular investments in tax-saving instruments
As discussed, you are eligible to save tax when you invest in ELSS funds. ELSS funds have a lock-in period of three years, before which they cannot redeem their funds. You can invest in ELSS via lumpsum mode or SIP mode, according to your convenience. The average returns on ELSS tax saving mutual funds account to around 12-15 % each year when invested for a longer duration.
- Protect your loved ones
You should avail a good life insurance policy to protect your loved ones from financial stress. Premiums paid towards life insurance policies are eligible for tax deduction u/s 80C of the Income Tax Act. If you have any dependents that are financially dependent on you, you must have a good life insurance policy or a term policy. You may also consider investing in ULIPs (Unit-linked Insurance Plans) that offer a combination of life insurance policy and investment opportunities in a single mutual fund scheme.
Tax planning, if done under the framework defined by the authorities, is a smart and legal decision. However, you might be asking for trouble for adopting shady tax-saving techniques. It is the responsibility and duty of each citizen to carry out prudent tax planning. Based on your personal choices, tax slab, and social liabilities, you can choose from distinct investment avenues offered to you. Happy investing!