Last Updated on March 15th, 2017

The term Tax Planning refers to the use of the tax saving instruments (deductions & exemptions) specified by the government so as to reduce the tax liability. This needs planning and prudent investment decision-making.

What Options does one have for tax savings investments?
The choice is wide enough. But what will take you closer to your financial goals?
Section 80C of the Income Tax Act allows deduction from taxable income, up to Rs. 1,50,000/- for the investment done by an assessee in Public Provident Fund, National Saving Certificate, Accrued interest on National Saving Certificate, Life Insurance Premium, Equity Linked Savings Schemes (ELSS), 5-Year fixed deposits with banks and Post Office etc. or other instruments specified in the section.

The need is to consider your personal financial goals while saving tax. Have a look at the options available under Section 80 C. Amongst the available options; ELSS has the potential to give investors benefit of long-term equity investments, diversification and professional management. Currently, Dividends and Long term Capital Gains of the ELSS are tax-free. Following are some of the options available to assess under section 80C of the Income Tax Act.

Options Available

EPF/PPF

Senior Citizen Savings Scheme

National Savings Certificate (NSC)

Bank Fixed Deposits of 5 years (FD)

Life Insurance premium

ELSS or any MF Scheme eligible for tax deduction under Section 80 C

Note: Instruments like PPF / EPF, NSC or Post Office / Bank FDs have implicit / explicit guarantee of Government of India or respective issuer for repayment of principal and interest. Investments in ELSS are subject to market risks and the NAV of units of ELSS may go up or down, depending on the factors and forces affecting the capital markets. Investors shall read and understand risk factors before making an investment decision.

Check out the capital market course for better understanding.

Why do you need to grow your Wealth and start Planning for Tax Early?
This is because of the following:

• To beat inflation i.e. preserve existing wealth
• To fund future needs
• To meet contingencies
• To maintain same standard of living year after year

Consider,

• Tax outflow will reduce your personal disposable income
• Inflation will reduce your buying power and wealth
• Maintaining life style becomes difficult without wealth

Are you weighing your options correctly?
The combined effect of inflation and changing lifestyles means balancing your finances without proper planning would become very difficult.

Therefore need of capital appreciation and tax savings and planning for the same arises.

The above example is for illustrative purpose only. The actual results may substantially vary.

We all view risks in our own way

• There is a risk to investing
• There is a risk to not investing as well!

How to plan for tax?

Planning is all about answering 4 questions:
1. What is your starting point?
2. What is your target?
3. How do you reach the target?
4. Are you on course?

Planning looks at four basic questions, where are you starting from, where and when do you want to reach, how do you get there and then periodically checking the progress and doing course correction, if required.

1. Your starting point is nothing but your current financial situation, which would include your current income, your future income and your present investment portfolio. These are your resources to help you reach your financial goals.

2. Next comes the question of identifying your financial goals. Financial goals need to be defined in terms of how much money would be required and time period when the money would be needed.

3. Having identified your financial goals and listed down your resources, you move to the next step of planning. This would require drawing the asset allocation and then selecting components among the asset classes. This step may require you to take professional help.

4. Any plan is prepared keeping some assumptions in mind as a plan is always about the future that cannot be correctly predicted. There will always be some surprises – pleasant or otherwise. A plan must be monitored periodically to check if we are going in the right direction.

Apart from the value of investment portfolio and the financial market situation, the more important aspect to review is one’s own financial situation, family condition, health, profession or any other major changes in life.

In view of above, let us look at the option of Tax Planning through Mutual Funds

Equity Linked Saving Scheme (ELSS)
As mentioned above, ELSS is one of the investment options available under Section 80C of the Income Tax. The maximum amount that is allowed as deduction from taxable income is Rs. 1,50,000/- (Rupees one lac only). It primarily invests in Equity and Equity related securities.

The difference between ELSS, National Saving Certificate (NSC) & PPF is that the lock in periods are 3, 5 & 15* years respectively (* partial withdrawals are allowed from 6th year onwards in PPF). It is more prudent to invest in the ELSS is by Systematic Investment Plan (SIP). According to SIP, every month, the investor invests a fixed amount of money in the market, through the mutual fund.

Over the long term, equity as an asset class does much better compared to other tax saving instruments. The general mistake investors make every year is they put the entire annual investment as lumpsum money in March. If the taxpayers invest in ELSS through a SIP, the investments will give more units in a falling market condition and when the market goes up, the total value of the investment also goes up. Thus, this evens out the vagaries of the market.

Currently, there is no capital gains tax on ELSS investments. You also have the flexible styles of investment in ELSS, viz., Lumpsum / SIP. The investors also get the benefit of diversification of portfolio in equities and professional management.

Please ponder over following:

All tax saving investments have a lock-in period

• You need to save tax, but traditional tax savings investments may not reward you enough for holding on for so long
• Since you have to lock the money for 3 years to invest for tax benefit, why not look for an investment that makes the 3 year wait worthwhile

This article is written by Mr Siddhartha Goenka, CFP, Senior Manager - Knowledge at Elearnmarkets.com