Tax planning for long was associated with LIC, PPF and NSC investments. Today we have a much wider choice which includes ELSS funds, ULIPs, long term FDs, NPS etc. The key point to remember is that your tax investments cannot be random and must fit into your larger financial plan. For income tax assessees, the beginning of the new fiscal year also marks the onset of the tax planning season. That is when most individuals start worrying about how exactly to reduce their tax outflow. The big debate over life insurance versus ELSS crops up at this point of time. While tax planning is a necessary ritual that everybody needs to go through, here are a few basic rules about planning your taxes. The whole of idea of tax planning is to hit two birds with one stone. On the one hand, you reduce your tax outflows and at the same time you allocate your monies into productive investments that can give you attractive returns over time. Here are some basic rules to follow in tax related investing.

Firstly, you must be clear about the engine in the entire process

This is the primary consideration before you embark on your tax planning. Your investments should be driven by your personal finance plan and not by the need to save taxes. A financial plan defines your long term goals and helps you create and monitor a financial plan to attain these financial goals. When you create your financial plan, there are 4 key considerations viz. returns, risk, liquidity, and tax efficiency. The process of tax planning should always be subservient to your overall financial plan. The common mistake most people commit is to let their tax saving requirements dictate their investments. In the process you end up making sub-optimal investments. To begin with, be clear that your financial plan is the engine for your entire investment activity. Your tax liability cannot be the engine of your investment process. In other words, your asset selection for tax planning and the quantum of allocation should be driven by your overall asset allocation in your financial plan. Moral of the story is to complete your financial plan first and then embark upon tax planning.

You pay taxes through the year; then why not plan your taxes also through the year

Talk to any chartered accountant and they see a spurt in their business towards the last 3 months of the financial year. That is when most people start planning their taxes. So you find a rush to buy PPF products, buy life insurance etc. This can be planned in a much better manner. Whether you are salaried or a businessman, you know your approximate tax liability at the beginning of the year or at least you can estimate it with a reasonable degree of accuracy. It makes a lot more sense to phase out your entire tax plan over a period of 12 months so that you are not overly burdened on the last 3 months. In the process, you also do not end up tying yourself to long term commitments like endowments which are not exactly productive from the perspective of your financial plan. For example, a simple way to do it would be to opt for systematic investment plan (SIP) on ELSS. This way you match your outflows to your inflows, get the benefit of rupee cost averaging and also create equity wealth in the long run.

Tax planning need not be done just through debt products alone

Tax planning, for most, boils down to investments under Section 80C of the Income Tax Act. Even within Section 80C, the focus is on products like PPF, NSC and long term FDs which are all fixed income products. As a smart investor you need to look at a combination of tax saving and creating wealth in the long term. How do you do it? Equity Linked Savings Schemes (ELSS) could be one such method. They are equity funds with a minimum lock-in of 3 years. This has 3 advantages. Firstly, an equity fund tends to create wealth over the long run. Secondly, due to the compulsory lock-in, fund managers do not churn the portfolio too often enabling better long term returns. Your investment in ELSS can be structured in the form of a systematic investment plan (SIP) which makes it a regular investment giving you the benefit of rupee cost averaging.

Tax planning and saving is not just about Section 80C, although is most popular

For most individuals tax planning gets down to Section 80C. The first thing you need to remember is that some part of Section 80C automatically gets covered for you. For example, the PF contribution is compulsory and you will also be paying tuition fees for your child’s education. Both are eligible under Section 80C for tax rebate. There are other important sections to save tax. Section 80D provides you benefits on buying health insurance for yourself and for your family. Section 24 provides exemption on interest paid on home loans. You can also claim deductions under Section 80D for donations made for specific purposes. Lastly, there is Section 80GG wherein you can get benefit of rent paid even if you are not eligible for HRA. So don’t obsess yourself with Section 80C alone.

Apart from tax saving, also focus on tax efficiency of your investments

This is a common mistake that most people make. When you invest in certain investment products, you get a tax exemption, but what about the tax treatment when you earn income on these investments and when you redeem them. Take the case of long term FDs and NSC. Both give you benefits under Section 80C in the financial year of investment. But interest on these products is taxed at your peak rate. In fact, in the case of NSC, the interest is accrued each year but you still need to pay tax on the accrued interest. PPF scores higher because the interest is also tax free and it is also exempt from tax when redeemed. Similarly, take the case of ELSS. Dividends on mutual funds may be taxed post April 2018 at 10% but this comes with a basic exemption of Rs.1 lakh per annum. In addition, you can structure your ELSS withdrawal in such a way as to reduce your tax liability to the bare minimum. When it is redeemed after 3 years, it is a long term capital gain and will once again be tax free. These are important considerations when planning your taxes.

Be cautious about committing your money and energy to long term commitments

Some of the endowment plans and ULIP plans may look very exciting and attractive on paper. But remember, these are very real long term commitments. In case of a ULIP plan, the upfront loading is so steep that it may take at least 7 years to break even, assuming that markets have been performing normally. When you get into a ULIP or an endowment, you are making a long term commitment and any early exit is either not possible or will come at a prohibitive cost.

Above all, make it a point to document meticulously and submit proofs on time

This may sound quite mundane but it a very important part of your entire tax planning exercise. Your monthly TDS is based on estimates provided in the beginning of the year and the proofs submitted before the cut-off date. Ensure that your proofs in the appropriate format are submitted on time. Today the tax filing process is largely online and hence there are extensive audit trails for you to check and confirm online. Make the best of the same. Basic checks like cross verifying with Form 26AS and Form 16 should be done well in advance to avoid any discrepancies and confusions later with respect to your tax returns.