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The big canvas of tax investments
TAX planning is always seen with an isolated view of saving
tax. This myopic view hurts individuals in the form of lower
post tax income, higher costs and a hodge-podge of investments
accumulated over a period. Contrary to this approach, tax planning
should be seen within the broader framework of financial planning.
Hence, one must start this process from April 1. However, for
the late bloomers, there is still time and rather than rushing
into it, take a holistic view of your liquidity needs, goals,
return objectives and risk profile and then make a prudent choice.
Here are some of our thoughts on how one should look at tax
planning:
• Are you contributing to EPF?
• Have you taken a home loan?
• Are you paying your children’s school fees?
If you are doing any of the above, it means you already contribute
to tax saving instruments under Section 80C. Calculate how much
amount you have already paid towards home loan principal or
as your contribution to Employees Provident Fund or children’s
school fees. Add all three and deduct this from Rs 1 lakh. The
difference is all that you need to invest and I have discussed
options below. However, for those who are not exposed to any
of the above 3 questions, take a holistic view of your situation.
Do you need a house? Go for it. You will get a deduction on
the principal investment as well as the interest component of
the loan. At such high property rates and in such a short period
of time (till March 31, 2008), this does not seem a viable option
but from a long-term perspective, it certainly would.
Do you have any dependants and liabilities? If yes, and if
you are in the accumulation phase (between 25-50 years), do
a needs analysis and look at insurance. The premium is covered
under Section 80C. Go for pure risk cover also known as term
insurance. This is the purest and cheapest form of life insurance.
Let’s say you are a 30-year-old male and you take a term
insurance for Rs 10 lakh for 20 years. Should you die during
this period, your nominee/ beneficiary will get Rs 10 lakh.
The annual premium that you will pay will be just Rs 3,000.
If you want a fixed return investment, then you have many
options. If you are salaried, opt for the Voluntary Provident
Fund. Also opt for the Public Provident Fund. Though some insurance
options and National Savings Certificate also fall into this
category, EPF, VPF, PPF and Senior Citizens Scheme (from next
year) still hold good. Unit Linked Insurance Plans are very
popular these days. Most insurance and ULIP policies are sold
during February and March.
Due to the transaction costs, high sales and other costs,
ULIPs eat into your returns. We strongly advocate looking at
Equity Linked Savings Schemes instead. These are mutual funds
that invest in stocks and give a tax benefit under Section 80C.
In the current context of the market, lump-sum investments would
be a good bet and considering the current situation and a strong
growth rate in the economy and corporate earnings, you can expect
good risk-adjusted returns over the next few years. What’s
the right choice? There is no silver bullet here. While VPF
has no limit (but varies with each company), PPF has a limit
of Rs 70,000, ELSS does not have any limit and you can invest
Rs 1,00,000 in it. When compared with PPF, NSC and traditional
insurance plans, the returns from ELSS are the highest.
Even as equities provide high returns over the long term,
it’s a risky asset class. It is prone to volatility and
there could be periods of negative returns. However, liquidity
is the shortest in ELSS.
The final step is to decide which fund to invest in. And as
the choice keeps increasing, choosing a fund is going to be
even more difficult. Therefore, investors should choose their
funds with utmost care.
Look at consistency rather than a one-off performance. Opt
for funds with proven track record in good as well bad times
and experienced managers. Goal of this exercise should be to
maximize post tax income. Have you just been investing to save
tax? Or, do you look at post-tax returns and whether this investment
is relevant to your overall situation?
Goals will help you decide your investments. When looking
at the Rs 1,00,000 component under Section 80C, keep all the
above parameters in mind. Then you can decide how much should
go into equity, debt, insurance and real estate.
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