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Simplifying income-tax planning
January, 25th 2009

Jog your memory and check if you have ever come across an individual who hasnt sighed after looking at his/ her income tax liabilities. On the contrary, youre most likely to remember people trying to make a series of investments before March or a colleague running frantically to find an insurance policy for the last Rs 30,000 he needed to avail of the entire Rs 1 lakh tax exemption available under Section 80 C of the Income-tax Act.

No doubt, tax planning is an extremely important activity but a lot of people seem to adopt a careless approach towards it. The attempt is, more often than not, to find a quick measure to deal with the moments needs. Most see this as a necessity that must be fulfilled but has no relation with their investment goals or financial plans.

Financial planners, however, say that tax planning should be considered a critical part of financial planning. Instead of jumping at the first instrument that appears on the horizon with the promise of a tax deduction, individuals should take calculated decisions and choose instruments that give them the dual benefits of tax reduction as well as good returns in the long term.

Fortunately for the Indian investor, there seems to be a number of instruments which cater to this two-fold need. Before you do so, however, take a look at your existing portfolio to see what deductions you are already eligible for and how much you need to make up. SundayET helps you out by telling you about some of the tax-saving investment avenues.

Tax-saving funds (or ELSS)

If youre looking at dabbling in equity but dont want to take the plunge on your own, you could look at investing in a tax-saving fund. This promises you a tax deduction of up to Rs 1 lakh under Section 80 C. However, these funds generally have a lock-in period of three years and it is generally advised that you only put in money that you will not require for the next three years at least. However, dividends and bonuses are not covered under this lock-in clause.

Fixed Deposits

If youre a risk-averse person who doesnt want to take the money out of the bank, you could contemplate putting your money into a fixed deposit. At present, only the five-year fixed deposit (of up to Rs 1 lakh) has the tax-saving elements associated with it. The current rates of interest seem to be about 8.25% for the general investor and 8.75% for senior citizens, which did not always match up to the rate of returns which are offered by other types of fixed deposits available in the market, but the benefit is that the maturity amount is currently tax-free.

However, in the event that one was to choose between investing in an FD or an ELSS, financial planner Veer Sardesai says, One should also look at tax-planning with the aim of maximising wealth and the predominant aim should be to find a way to make the money grow faster. If you are looking in terms of returns, then ELSS are in a position to give a better return than FDs. However, if a person is keen on putting money into FDs, then Sardesai adds only ones contingency fund should be invested via this avenue in the current situation.

Insurance plans

According to Kartik Varma, co-founder, iTrust Financial Advisors, In the bid to increase post-tax returns, many individuals in the 35-45 age group often end up buying policies year after year, many of which they do not need.

Nevertheless, experts suggest that if youre looking at insurance, then you should look at a plan which is not pure protection but also has an investment opportunity built into it such as a ULIP. Amitabh Singh, tax partner, Ernst and Young, justifies this by adding that Payouts from life insurance policies are free from tax. Hence, even getting a 10% return post-tax from an insurance policy will be considered good.

Exemptions on loans

Home loans and educational loans are the two categories under which deductions are available. Most loans generally have a time period of 10-20 years and many people think that they can avail of tax benefits by having a long repayment period. Singh, however, points out that the tax deduction under 80 C is only available for the repayment of the principal amount.

Tax deductions on the interest component comes under Section 24 and will vary based on whether the home is rented or self-occupied. For a long term loan, the interest component will be very high and if the interest to be paid seems to be more that the deduction that is available on interest, then you should perhaps reconsider the decision. For educational loans, the interest that you pay will be tax-deductible.

Savings schemes

For risk-averse investors, there is also a set of small-time savings schemes that will give you assured returns as well as tax benefits. For instance, annual contributions made to the Public Provident Fund (PPF) over a 15-year period will give you interest at the rate of 8% (this is subject to change) but the tax benefits are available only up to Rs 70,000 under Section 80C. The income that is garnered from the interest however is considered tax free under Section 10(11) of the Income-tax Act.

Meanwhile, there are other schemes one could look at, such as putting your money into a National Savings Certificate (NSC) or a five-year post office time deposit or a senior citizens savings scheme if you are above the age of 60 or have taken voluntary retirement at the age of 55. Mediclaim policies taken for yourself or your parents will also allow you to get a tax-deduction under Section 80 D up to a maximum of Rs 35,000.

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