Tax Planning: Early Bird Gets The Worm

A famous Morgan Stanley advertisement of 2006 grabbed a lot of attention for its punch line which stated, “You must pay taxes. But no law says you have to leave a tip.” For the investor community, it highlighted the importance of not neglecting the opportunity to lawfully save on taxes. As you are aware, the lower amount of tax you pay, the greater your disposable income is. Quite often, many investors unknowingly make some common mistakes while planning to save their taxes. In this special report, we will discuss such mistakes that must be avoided and provide suggestions to rectify them.[EasyDNNnews:PaidContentStart]

Start Early

As a cricket-loving nation, we all know that only M S Dhoni can turn a match in the last over and win it for India. But it is observed that tax planning is something that a lot of investors put off until the fourth quarter. Many investors wait until they are asked by their employers to produce Section 80 C and other investment evidence for tax deducted at source (TDS) reasons before starting their tax filing. The last minute hurry to make tax-saving investments before their employers’ deadline prevents them from giving these investments more thought or connecting them to their financial goals. 

Investors frequently make sub-par tax-saving investing choices that they regret at a later stage. At the start of the fiscal year, a majority of salaried investors are aware of the fixed portion of their pay. Additionally, you are aware of the interest rate on your current bank fixed deposits. This is a really good time to start and you can begin your tax preparation in April. It will ensure you have enough time to thoroughly plan your investments and choose the best ones. Therefore, avoid the error of delaying your tax planning until March. As soon as you can, flag off the process.

Take a Long-Term View

Last quarter investment can hamper the long-term interest of your financial goals. The interest and returns you could have received if you had started your tax planning earlier in the year are lost when you wait until the fourth quarter to do so. This might be a substantial amount for an investment of about ₹1-5 lakhs. Using a 10 per cent annual return as a baseline, the return after 10 months on a ₹1 lakh investment is ₹8,333. Simply by waiting until the final quarter to make your taxsavings investments, you might lose ₹5-8 lakhs in the long term of 20-25 years

Many investors might not have enough investable assets to make all of their tax-saving investments at the beginning of the financial year, even though some investors devote a portion of their annual bonus, which they get in February or March, to tax-saving investments for the following year. You will receive returns on all your monthly contributions if you invest in mutual fund equity linked savings schemes (ELSS) through a monthly systematic investment plan (SIP) from your regular savings. You will also gain over the long run from the power of compounding.

Tax Planning is not Investment Planning

This subject was briefly discussed before. However, for the sole purpose of saving taxes, the majority of investors participate in tax planning automatically. Do remember that tax planning involves more than just reducing taxes. It needs to be connected to your financial objectives. You should invest in plans that will help you achieve your financial objectives while also saving you money on taxes. Various Section 80 C investment plans have various risk and return characteristics. You should invest based on your risk tolerance and financial objectives. However, smart tax management involves more than just investment. The second crucial element that doesn’t get enough attention is how you handle your finances.

According to Income Tax legislation, you are permitted to deduct a variety of expenses from your taxable income. For instance, costs that qualify for a tax deduction include paying for children’s tuition, health insurance, home loan repayment, student loan repayment and rent. Unfortunately, a lot of taxpayers are unaware of or don’t take the time to comprehend these parts of tax management, and as a result, they wind up paying thousands of rupees in taxes that they might have simply avoided. You should investigate each of these tax-saving solutions as a taxpayer to see which is most advantageous for you. Your possibilities of lowering your tax burden increase with how well you know the tax rules and how quickly you put them into action.

Confusion over Tax Planning & Insurance Needs

Even though there is far greater awareness, this is a fairly prevalent error. One of any family’s most crucial financial necessities is life insurance. In the tragic event of your passing away, inadequate life insurance coverage might put your family in great financial danger. Therefore, life insurance has to be a distinct goal and should not be combined with investments or tax savings. Before making any other investment decisions, you should determine how much life insurance you require and get enough coverage.

Millions of Indians mistakenly enrol in traditional life insurance plans like endowment and money-back policies every March to reduce their tax burden. In fact, there is such hurry at the last minute that life insurance firms have successfully advertised March as India’s tax-saving season. And it shouldn’t be a surprise that the typical life insurance policy sales for the full year generate 20 per cent of the revenue for insurance firms. You don’t need to seek further than your friendly neighbourhood insurance agent to get the answer to the questions of why these products are sold and who profits from them. Large commissions are offered to these agents as incentives for the sale of these policies. They thus make a consistent effort to market these policies. 

There are various government-backed tax-saving instruments available if you are seeking really secure investments and safety is more essential to you than rewards. The returns from these plans are higher than those of a conventional life insurance plan. Similarly, be prepared to handle some volatility if inflation-beating returns are more essential to you. NPS, ULIP and ELSS are some of the options available. The area of investments that save taxes has a wide range of options. You may choose the best investment possibilities by using straightforward decision-making criteria including risk, liquidity, returns and taxes.

Liquidity and Tax Planning

When investing in tax-saving instruments, it would be preferable to take your liquidity demands into account. Most tax-saving investments have lengthy lock-in periods and if income is needed immediately, it cannot be generated by selling the investment before the lock-in period ends. For instance, if you invest in NPS under Section 80 CCD (1b), there is a significant lock-in period and no early withdrawal is allowed. Your tax-saving investments should be made in a way that they satisfy your needs for cash flows. If saving money up to retirement is okay with you, well, that would be excellent! Try it out! However, not all individuals can manage to set aside savings up to the retirement phase since there will always be occasions when huge amounts of money are required to deal with certain events.

Further, you should take into account the liquidity component of any tax-saving investments if you want high liquidity or have financial objectives that require cash soon. It is important to note that ELSS has a three-year lock-in period that is the shortest. ELSS allows an individual or HUF a deduction from total income of up to ₹1.5 lakhs under Section 80 C of Income Tax Act.

Conclusion

Tax planning decisions made in haste and in limited time can cause financial losses and reducing tax liability through investments at the final moment can be one such lethal decision. To assure that you do not suffer irreversible financial losses, it is best to start incorporating tax planning with overall financial planning and start well in advance. Making intelligent investment choices that are in line with your overall financial goals is just as crucial as tax planning. To protect your financial future, stay away from the above mentioned typical tax planning errors. For better outcomes, start your tax preparation early and use a comprehensive strategy.

Many taxpayers frequently commit costly errors that may have long-term repercussions when the deadline for tax-saving investments draws near. Tax savings are crucial, but doing so in isolation rather than as a vital component of your entire financial planning approach might result in bad investment choices. Investments made for tax planning are identical to those made for other purposes. Managing tax-saving investments follows the same fundamental rules as managing other investments such as asset allocation or diversification. Now that you are aware of the most typical and preventable tax planning blunders, how about you starting your tax planning journey right away? 

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