This time be a Tax Planner (not a Tax Saver)....

March 2014 is upon us. Its tax saving season(for some). But why only march, why not April 2014? Just because the financial year is coming to an end?(its not the end of the world) A number of savers wake up from their 11 month slumber to the realisation that they have to save tax.

I have come across several investors who have bought insurance policies like Money-back, endowment plans and ULIPs or any other(unwanted) products to save taxes. This is a common mistake most of the investors do. They just don’t realize that they are trapped in these unwanted products because of their obsession with Tax saving. Most of them are today 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!!”

This reminds me of ....

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 saving 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 a prudent way for tax savings?

ABSOLUTELY NOT!. Remember, merely buying products to save taxes will never drive it towards “Tax Planning”.

In my opinion, tax saving is a just another path towards the tax planning exercise.

75% of the people invest their money only for saving tax, 20% of them invest so that their Money can 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” you take into consideration one’s comprehensive 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.

Other common Mistakes of a 11th hour tax saver:

1. Buying Unit Linked Insurance Plans

2. Ignoring power of compounding through PPF and or tax saving mutual funds.

3. Not optimizing all options for tax savings

4. Acting under Agent/ Distributor’s control

A Prudent exercise of tax planning extends to appropriate investment planning, which also takes into account your ideal asset allocation by considering the under-mentioned factors: (after you have utilized the tax provisions within each head / source of income)

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) and National Pension System (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 the number of years of repayment is more along with your willingness to take risks being high.

Income - Similarly, your risk taking capacity increases with higher income. 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 investments, 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 increases, which can also help you to optimally reduce your tax liability. Make sure that you do not just take a Home loan for saving tax, that could actually spell a disaster for your long term goals like retirement.

Financial Goals - 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.

Restructuring your Investment Plan:

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 plan in such a way so 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 products for tax saving:

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. Health Cover: The next thing you should target is Health Insurance. Better take a Family Floater Plan for your Family and the premium will be exempt under Sec 80D up to a maximum of Rs.15,000/- annually.

3. 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 7+ yrs). If the goal is extremely critical and you are not a risk taker then the best thing would be PPF. If you can take some amount of risk, you can invest in a combination of PPF and ELSS(Tax saving) Mutual funds.

 Conclusion

Tax planning should always be done at the beginning of the financial year. Always, so that you don’t take wrong decisions in a hurry. But if you are late, then you are better of saving tax by investing into low risk products like NSC/PPF or a 5yr Tax Saving Fixed Deposit for the time being.

Disclaimer : Funds are used for depicting long term performance and should not be construed as advice for investment.

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Image source Valueresearch online 

Data Source: Financial Planners Guild of India