The irony about tax-planning is that for most of the time its only about the tax and zero planning.
With a slightly better understanding this blind approach to tax-planning can evolve into a more beneficial exercise. So let’s invest a little time in understanding how tax planning is supposed to work.
What is tax planning
Tax-planning involves investing (or making ‘contributions’ as the taxman puts it) to reduce tax liability.Some of the popular tax-saving avenues include:
- Life insurance (term plans, endowment plans, ULIPs)
- Tax-saving funds or ELSS (equity-linked saving scheme)
- Tax-saving fixed deposits
- Repayment of principal amount on home loan
- Public Provident Fund (PPF)
- Post office schemes like National Savings Certificate (NSC)
Tax-planning is a simple 2 step process:
Step 1 – assess all the tax-saving avenues at your disposal and
Step 2 – match them with your goals
In the process you collect a tax benefit.
This is how tax planning is supposed to work.
But often individuals get it the other way round – they start with the wrong question. So the first question they ask is – ‘how much tax will I save? Then I will buy whatever you are selling.’
Tax-planning being such a ‘shoot in the dark’ process, individuals are robbed of significant gains that they could have registered with a proper plan.
Rakesh plays blind
Rakesh, a 32 year old, is a salaried employee in the private sector. He is married, with two kids.
Rakesh needs to save money for:
- child’s education
- retirement
- an outstanding home loan that must be paid off when he is not around
As far as his tax plan goes, Rakesh like all others can avail Rs 1.5 lakhs in tax-savings under Section 80C.
He already has about Rs 1 lakh of the Rs 1.5 lakhs covered in EPF (employee provident fund) and repayment of interest on home loan.
He should invest the balance Rs 50,000 to maximise his tax-savings and achieve his aforementioned stated goals.
Rakesh is considering a couple of tax-saving options like National Savings Certificate (NSC) and tax-saving fixed deposit based on opinions from the media and small talk at the office.
Busy as he is, he neither has time nor the knowledge to make an informed decision and goes for the options that appear less time consuming.
So this is how Rakesh ends up with tax-saving options that do not contribute in any way towards his three goals of protection, child’s education and outstanding home loan.
Such a ‘blind’ / haphazard approach to tax planning is exactly what individuals must avoid.
Life insurance can help Rakesh achieve all his goals if he divides the Rs 50,000 outstanding tax benefit in this manner:
- Opt for a term plan with a yearly premium of Rs 11,000
- Targeted savings of Rs 14,000 through an investment plan
- ULIP premium of Rs 25,000 towards children’s education
Collectively Rakesh is covered for the outstanding home loan, child’s education, and retirement with the Rs 50,000 tax saving money.
Tax-planning with a vision
Rakesh could have achieved all his goals with a little more vision. He only needed to invest a little time in outlining the goals and matching them with the right tax-saving solution – in this case life insurance (term, endownment and ULIP).
There is a lot individuals can achieve with a leg up from tax-savings under various sections. However, they need to plan with a vision as opposed to investing blind.
With a vision, you go straight for your goals with or without tax-savings. If you get a tax benefit, all the better. When you invest blind you go for tax benefits, whether or not you achieve your goals.
