Most taxpayers approach their tax-saving investments with the sole objective of saving tax for the current year. As long as investing in the chosen instrument results in getting the tax deduction, their immediate purpose is solved.
The instrument of choice is more often than not something recommended by a colleague or promoted heavily in the media.
And if you are senior management or a businessman then you have already been anointed an high networth individual and assigned a 'relationship manager' whose sole purpose in life is to force-feed you the latest flavours of the season. The result of this is, at the end of the day, you end up tax saving but not tax planning.
Take for example Section 80C, which is anyway the only meaningful deduction left. Under this Section, as most of you would know, any investment up to Rs 1 lakh made in certain specified instruments can be reduced from your taxable income.
There is a long list of eligible investments including an employee's provident fund contribution, tuition fees paid for children, principal portion of housing loan installments, investments made in public provident fund (PPF), equity linked saving scheme (ELSS), national savings certificates (NSC), senior citizen savings scheme, post office term deposits, life insurance premiums paid etc.
If you think about it, these are the very investments that one anyway makes. All you need to ensure is that these are integrated into the larger picture, in line with one's risk profile and financial goals.
Using Section 80C optimally
So how should an investor choose from amongst the various choices available? Here's what you should do. First take into account mandatory payments like provident fund, housing loan EMIs and tuition fees, if applicable.
Reduce the total amount spent from the Rs 1 lakh limit. Distribute the balance in a combination of ELSS and PPF. If you are relatively young and just starting out, put 70% into ELSS and 30% into PPF. As you advance, lower the ELSS and increase the PPF, eventually reaching a 30% ELSS and 70% PPF combination.
Why PPF? Well, it is the best fixed income investment that you can make. An annual contribution of Rs 70,000 will get you around Rs 32 lakh in 20 years. Look at it as a fund for the education needs of your children. If they don't need it, get your spouse to invest too and you would have a retirement fund ready.
An ELSS is nothing but an equity mutual fund that offers a tax deduction. On account of the tax deduction, there is a lock-in of three years on the investment. This lock-in enables the fund manager to take long-term calls on the market, which is essential for any equity investment.
ELSS investments are the most preferable way to build long-term wealth. However, this investment comes along with the inherent risk of the stock market, hence the suggestion that the proportion of ELSS in your total tax-saving investment should come down as age advances and the risk taking ability declines.
Recycling old investments
Take the case of one of my friends, Amit, who is into web design. His lament was that he had over Rs 5 lakh in receivables but customers in general were holding out for higher credit periods.
Since our income tax law taxes income on accrual and not on receipt, this means he has to pay the tax on the Rs 5 lakh not yet received. He was finding difficulty in arranging funds required to pay his employees for the month; so to keep anything aside for tax saving was a long shot.
In such cases, one can use another tax planning tool. I call it recycling. Amit can simply withdraw an earlier investment (from ELSS or PPF) and redeposit the money, even in the same instrument. He will get tax deduction for no additional outlay — in other words, his savings remain the same, but without investing a rupee, he can avail of the 31% tax saving.
Last but not the least
As mentioned earlier, your tax-saving investments are no different than your regular ones. Consequently, the basic principles of investing remain the same.
Therefore, next year, instead of waiting till the fag end, start by investing in tax-saving avenues in the very beginning of the financial year, even on the 1st of April. Doing so has a two-fold advantage.
First, these investments would earn a return from the beginning of the financial year. Secondly, often, many end up simply not having the lump sum required at one go for 100% tax saving. A more efficient strategy is to invest throughout the year in a staggered manner such that by the time the year comes to an end, full advantage of the tax-saving opportunity is taken.
And don't worry about how much or little you save each month. As Benjamin Franklin has so succinctly put it, "A penny saved is a dollar earned!"
