Tax saving is not Tax Planning !
“I have several insurance policies like Money-back, endowment plans and ULIPs or any other market linked products to save my taxes.” This is a common enough statement. Only that they don’t realize that they have got trapped in unwanted products because of their obsession with Tax saving. Most of the people today are investing in products which do not suit them, which they don’t need, which they do not understand. All because of their idiotic decision of “Investing for Tax Saving!!”
SANTA: Why are you throwing your money in the Pond? !!
BANTA: YOU KNOW WHAT!! Govt. Says that we can save up to Rs. 30 in Tax for every Rs. 100 we throw in this Pond!!
For some people the Products they buy for Tax savings are like This Pond, They are not sure what they will get from buying it, but they are happy about the fact that they are saving some money in tax!
But have you ever wondered whether it is prudent way for tax savings? Absolutely NOT!. Remember, merely buying products to save just taxes will never drive it towards “Tax Planning”.
In my opinion, tax saving is a sub-optimal way to undertake a tax planning exercise and 60% of the people invest their money for tax saving only, 35% of the people just invest Money to make it Grow and 5% of the people do proper Goal based investing.
Unlike “tax saving” which is generally done through investments in tax saving instruments/products, under “tax planning” we take into consideration one’s larger financial plan after accounting for one’s age, financial goals, ability to take risk and investment horizon (including nearness to financial goals). And by adopting such a method of “tax planning.”, you not only ensure long-term wealth creation but also protection of capital.
Mistakes while doing Tax Savings
- Tax planning at the 11th hour.
- Buying Unit Linked Insurance Plans
- Ignoring power of compounding through tax saving mutual funds
- Not optimizing all options for tax savings
- Under Agent/ Distributor’s control
A Prudent exercise of tax planning also extends to appropriate investment planning, which also takes into account your ideal asset allocation by considering the under-mentioned factors. Hence after you have utilized the tax provisions within each head / source of income for effective reduction in Gross Total Income (GTI).
Parameters for ‘prudent tax planning’
You must also consider the following parameters as these will enable you to optimally reduce your tax liability.
- Age – For prudent tax planning, if you are young, you should allocate more towards market-linked tax saving instruments such as Equity Linked Saving Schemes (ELSS), Unit Linked Insurance Plans (ULIPs) and National Pension Scheme (NPS), as at a young age, the willingness to take risk is high. One may also consider taking a home loan when you are young as number of years of repayment is more along with your willingness to take risk being high.
- Income –Similarly, if your income is high, your willingness to take risk is high. This can work in your favour, as you have sufficient annual Gross Taxable Income (GTI ) which allows you to park more money towards market-linked tax saving investment instruments, for generating higher returns and creating a good corpus for your financial goal(s). Also, on account of the higher GTI your eligibility to take a home loan also increases, which can also help you to optimally reduce your tax liability.
- Financial Goals –The financial goals which one sets in life, also influences the tax planning exercise. So, say for example your goal is retiring from work 5 years from now, then your tax saving investment portfolio will also be less skewed towards market-linked tax saving instruments, as you are quite near your goal and your regular income will stop.
Likewise if you are many years away from the financial goal, you should ideally allocate maximum resources to market linked tax saving instruments and less towards those instruments (tax saving) which provide you assured returns.
Restructuring of your Investment Planning
Tax Saving is just a benefit provided when you invest your money. Don’t make it as a Primary objective to Invest. What you have to concentrate on is your Tax Planning. You have to restructure your Investment planning in such a way as to get Tax Benefits from them. Tax Planning comes first and Tax saving second. If you are not able to save tax, it’s fine, Pay taxes.
Hierarchy of investing products for tax savings
1. Life insurance: Make sure you have adequate life insurance cover. If not, take a term insurance for amount of the cover you are short of. Protection is the first step of successful financial planning. Take a Term Plan from two Insurers.
2. Planning for Long Term Goals: Make a list of goals for long term like Retirement, Child Education, Child Marriage etc (Anything with a target date of 5+ yrs). For these goals you can invest in Tax saving Instruments. If the goal is extremely critical and you are not a risk taker then the best thing would be Tax saving Fixed Deposits. If you can take some amount of risk, you can invest your money in ELSS Mutual funds.
3. Health Cover: The next thing you should target is your Health Insurance. Better take a Family Floater Plan for your Family and the premium will be exempted under Sec 80D up to max of 15,000.
4. Short term Goals: If you have any short term goals then do not put money in any tax saving instrument, rather put money in non-tax saving instruments like Plain FD.
Tax saving should be done at the start of year always so that we don’t take wrong decisions in hurry. But if you are late you can take some logical decision and still do your tax planning.