Options that could match your goals and risk appetite
It's that time of the year, when most of you would have got the penultimate call from your employer for submitting proof of tax-saving investments. So is it going to be another year of ad hoc investing to reach the Rs 1 lakh figure allowed by the Income-Tax Act?
Here are a few tips that can add clarity to this yearly exercise that most of us perform mechanically.
The tax deductions permitted under the Income-Tax Act can broadly be classified into allowable expenditure and tax-saving investments. While the former can determine the tax slab you fall into, the latter, which we will delve into more, is vital to achieving your financial goals.
The most common expenditure that can reduce your taxable income is the house rent paid for a given financial year. But if you are already the proud, young, owner of a house, it is double benefit! You get a deduction on the annual interest paid on such loan up to Rs 1.5 lakh (more on the instalment amount later). So this head of expense can substantially lower your taxable income (before Section 80C deductions) that determines the tax bracket you fall into.
For example, with an income of, say, Rs 2 lakh per annum, you fall in the 20 per cent tax bracket; the above expense may well bring you down to the 10 per cent limit! That makes a huge difference to your tax outgo.
The `Section 80C' boon
Most of us know that up to Rs 1 lakh is allowed as deduction from our total income for investments made in specified instruments. But why is it so often quite divorced from your regular financial planning process? Think again.
Your tax-saving measure is just another form of savings after all. Your risk-appetite and time horizon are two important factors to be considered before jumping into any tax-saving vehicle, or for that matter any investment.
Being young, you may have short-term goals such as buying a car or funding an MBA degree. Putting your eggs in a five- or six-year vehicle may leave you with little money to meet such short-term goals.
Further, if you are not averse to the equity market roller-coaster and, then, with the comfort advantage of age, you can consider allocating a part of your funds to equity-linked tax instruments instead of the traditional debt options.
Keeping these two aspects in mind, a look at a few options. Repayment of housing loan instalment should be your first claim for income-tax deduction. This is likely to cover a chunk of the Rs 1 lakh and is one of the most beneficial financial-cum-tax planning measure. If you have children, then you can claim the tuition fees paid (up to Rs 1 lakh).
Securing your life and beyond...
A common error that the young-employed commit is to hurriedly purchase an insurance policy just to get that last-minute tax-cover.
Your first insurance should offer you a simple pure risk cover on your life. Known as term insurance, they are not linked to returns.
Instead, they offer high insurance cover at a low cost and act as the first social security one can provide to the family.
You can move on to other policies such as endowment (such as money back or child plans) or pension plans at a later date.
Medical insurance also qualifies for deduction of up to Rs 10,000, outside of the Rs 1 lakh benefit. However, you should consider this only after knowing the nature of medical cover your company provides you and your family.
A tinge of risk
While it is prudent to go for safe tax vehicles, you may even perk your overall portfolio returns, if your financial goals and risk appetite allow you to do so.
Here is where tax-saving funds and unit-linked insurance plans can help. These instruments, which come with a lock-in period, give you exposure to equity and the time to absorb the ups and downs of the stock market.
Choose the product that has a good track record of at least three years and a style that fits your risk appetite.
For instance, a fund with a large-cap exposure may be more suitable for the less risk-tolerant.
Remember that not all your money should be parked in equity-linked schemes.
Even with a reasonable appetite for risk, your investments in these schemes should ideally not exceed 60 per cent of the total funds allocated for tax-saving.
The safe haven
The time-tested National Savings Certificate, Public Provident Fund and, now, infrastructure bonds and five-year fixed deposits, should form part of the debt options.
While PPF, with a 15-year time frame, sounds long-drawn, the tax-free interest makes it attractive. Open an account while you are young and slowly increase your contribution as you become less risk-tolerant.
Your contribution towards employee's provident fund (EPF) also falls within the Rs 1-lakh ambit. You can also ask your organisation to deduct a higher amount towards EPF, over and above the minimum that is normally deducted from your salary. A number of EPFs run by trusts have returned handsomely. Check out the history in your organisation. This is by far the most disciplined vehicle to save money.
Remember, in financial decisions, the `rush-hour' can do much harm. For one, it may be difficult for you to gather a lumpsum at a short notice.
Second, you may end up with a wrong product that runs diametrically opposite to your overall financial goal. Like all other investments, make it a habit to invest systematically in tax-saving options.