It’s that time of the year again where we head towards the end of the financial year. It is a perfect instance to review whether we have smartly utilized all avenues of tax savings.
Most of us think of investment only after being nudged by our employers to submit proof of how we intend to reduce the tax burden. It is quite common to find people rushing to invest in tax saving instruments in the last few months of the financial year and thus end up buying products that are not right for them. Tax planning should be done months ahead as it gives you ample time to understand and evaluate different options that are specific to your financial situation.
There are the conventional tax saving options such as the Public Provident Fund (PPF) and life insurance. They may look less attractive in terms of their returns, but they offer high levels of safety of your investments.
Financial consultant Mr. Raghuvir Yadav lists out some simple, must-follow tips for planning your taxes in 2010-11.
Section 80C - All time favourite
Though there are other sections too, this is the most important providing tax benefit up to Rs.1 lakh on certain investments. Popular among the investment options are Employee Provident Fund (EPF), PPF, National Savings Certificate (NSC), 5-year bank fixed deposits, life insurance policies, Equity-Linked Savings Schemes (ELSS), Unit Linked Insurance Plans (ULIPs), school fees and home loan principal repayment.
Before making investments to seek benefits under Section 80 C of the Income Tax Act, you have to decide on the ideal debt vs. equity mix based on your age, risk-return profile and goals.
While planning taxes, an individual needs to make sure that he/she fully avails the deduction of Rs.1 lakh under the Act. The choice of the appropriate investments would depend on the specific situation of the individual such as age, marital status, investment objective, etc.
For example, where an individual is an unmarried, young employee and staying with parents, he/she should take into account the PF deducted by the employer from the salary. PF contribution is mandatory and the resultant tax breaks are automatically reflected in the salary slip. Hence the other investments should be to make use of the remaining tax benefits under the Section.
If the individual is married and has school/college going children, then besides PF, he would also need to consider tuition fees he would be paying to ascertain the remaining amount to be invested in tax saving instruments.
Home loan - the big tax saver
Tax payers who have availed of a home loan need to consider the principal amount to be repaid during the year since such principal repayments get tax breaks under Section 80 C.
The amount of interest paid on home loans is separately deductible up to maximum of Rs 1.50 lakh. In the event of any increase/reduction in the floating interest rate on home loans during the year, your estimate would also undergo change and the amount to be invested in tax saving instruments would also need to be reworked.
If you have taken a medical insurance plan for yourself, your spouse, dependant parents or children, you can claim deductions up to Rs.15, 000 (and an additional Rs 15,000 for your parents' medical insurance) under Section 80D. The limit now has been enhanced to Rs.20, 000 for senior citizens on the condition that the premium is paid via cheque. Expenses on the medical treatment of a dependent with a disability qualify for tax benefits under Section 80DD. In this case, deductions up to Rs 50,000 or Rs 75,000 can be claimed based on the severity.
For investors who are wary of equities
Equity Linked Saving Schemes (ELSS) and Unit Linked Insurance Plans have had been the flavour for past couple of years. But, the outlook seems different this year. The retail investors are still cautious about investment in equities as revealed by mutual fund industry.
Obviously, they are looking for alternative tax-savings instruments that are safer and steadier than high volatile equities.
One such safe instrument is the National Saving Certificate (NSC). The amount invested under NSC is exempted from tax liability. Such invested amount fetches a fixed rate of interest at 8 per cent compounded half yearly. NSC is a long-term investment option offering assured returns and issued for a maturity period of six years.
If someone buys NSC worth Rs 50,000 today, he/she is entitled to get around Rs 80,000 at the end of 6th year. Instead if someone parks the equivalent amount in bank deposits for the same time frame, the maturity proceeds will be around Rs 74,000. It is because the deposit rate offered by banks is lower. The important thing to note is that there is no upper limit on investment in NSC. Investment up to Rs.1 lakh per annum qualify for IT rebate under Section 80C.
NSC, however, is not a liquid instrument. Once purchased, one cannot withdraw money before maturity. The interest paid at the time of maturity is not tax-free.
Yet, considering the lower deposit rates offered by banks, NSC could be an ideal investment for those seeking tax benefits on a long term basis and not worried about liquidity. Bank deposits with a lock-in period of five years too provide tax benefit under Section 80C.
Shuffle and switch strategy
Shuffling is a popular strategy used by ELSS investors. ELSS is a category of mutual funds where a major portion is invested in equity and equity-related instruments. Investment up to Rs.1 lakh is exempted from income under Section 80C but there is a lock in of three years before which you cannot withdraw. However, there is no upper limit on investments and long-term capital appreciations are tax free.
If you have been investing Rs 50,000 for the past few years and don’t have cash to invest this year, you can easily redeem investments made three years ago and re-invest them this year to claim the benefits.
You will not have to pay any long term capital gains since you will be redeeming after more than a year. Thus you can enjoy tax benefits without making any fresh investments. Only risk is that the Net Asset Value (NAV) can go up or down in the shuffle process and you may end up making a small profit or loss.
Charitable donations are tax smart
While donations should not be made simply for tax purposes but for philanthropic reasons, you can always make a couple more at the end of the year to lower your tax. You get a tax relief if you donate to institutions approved under Section 80G of the I-T Act. The rate of deduction is either 50 or 100 per cent, depending on the choice of the charity fund. There is no restriction on the amount given to charity.
Divide your income
Normally, if you invest in your wife’s or child’s name, the income generated from such investments will be clubbed with your income and taxed accordingly. However, if you transfer money through a deed to a child who is aged over 18 and invest in his/her name, then the income generated from such investment will not be clubbed with your income. Instead, that will be clubbed with the income of your child/wife and taxed accordingly.
Cash gifts received from specified relatives are exempt from income tax and there is no upper limit. Similarly, cash gifts of any amount and from anyone received during your child birth, marriage or any other specified event are totally tax-free. You should make sure that you have a record and valid receipts for all tax saving investments made in your name.
According to Mr.Yadav, these are some of the prominent investments/tax-saving options. Most of these sections will be valid till the new tax code implementation, which is expected to be in place in the financial year 2011-12.
In a nutshell
Combine tax planning with financial plan
Consider getting a loan while buying a home.
Charity is good - not only for the receiver, but the giver as well
Insuring oneself and family members make good tax sense
Medical insurance - care for your family and get tax breaks
File your taxes on time