Does your tax planning give you a break or does it break you?
January, 13th 2010
A look at the various tax saving tools available and their significance in your personal finance life.
While the role of the Tax Man is to maximize the tax collection, he also gives tax breaks that reduce the tax paid by us.
On the surface this looks very contradictory to the objectives. But it makes sense when we have a holistic picture.
The Current Tax Benefit Tools: Section 80C
Section 80C of the Income Tax Act gives tax benefits in the form of reduction in the taxable income up to Rs.1, 00,000/- per year.
Of the investments in Section 80C, ULIPs and ELSS (Tax Saving Mutual Funds with 3 years lock-in)could be considered by investors with a long term (above 7 years and 3 years respectively)investment purpose. EPF is unavoidable for the salaried employee, so it becomes an automatic investment.
Term Insurance for the bread winner(s) of the family is a must for any family that gets the tax benefit. But very few families in India have one.
Children' education is one other component that gets this benefit.
Other savings instruments like PPF, Postal deposits are better when not invested for tax purposes as the returns are very low for their long lock-in periods.
Principal component of the housing loan repayment is a positive inclusion in Section 80C. But when this component is included the space of Rs.1,00,000/- it becomes relatively small.
Allowances: House Rent Allowance
Upto 40% (50% in case of the Metros) of the basic pay OR actual HRA received OR rent paid above 10% of basic pay which ever is LESSER is exempt from income as the House rent allowance.
Sometimes we see pay slips with HRA equal to 100% of the basic. There is not much benefit here. Please talk to your HR manager on whether you can have some flexibility to design your pay subject to the same CTC (Cost to Company).
This is an allowance that is still set at the archaic Rs.800 per month.
Leave Travel Allowance
There is flexibility now in the way LTA is to be processed. We do not have to submit the bills to the company to claim it. That looks like good news. However the hitch is that the IT department can ask for the original bills at their discretion.
This can be claimed only 2 times in a block of 4 years. Retain your bills. Ensure that what you claim is what you 'actually' spent.
Section 24: Housing Loan Interest Component
There is a benefit of reduction in taxable income upto Rs.1,50,000/- per year for the interest component of the housing loan. Though there is a considerable reduction in the taxable income, it should be remembered that this cash flow is a negative cash flow that does not add to one's wealth.
The way to look at it is, when we shell out Rs.150,000/- the maximum tax benefit that we get is probably 30% (at the highest tax slab). This is Rs.45,000/- in the form of tax benefit. If we had paid the tax instead, you may have lost Rs.45,000/- but will be able to invest/ use Rs.105,000/- the way you want to. By only thinking of saving the tax you actually lose out on paying as interest an additional Rs.105,000/-.
The other angle to this is that the interest component of the loan keeps decreasing as the years progress, thus negating the benefit of tax savings too in the latter years.
Creating wealth using tax breaks
Investments like the ELSS, long term investments in ULIPs (please do not take the sales agent's view of investing for 3 years), pension plans like the EPF and New Pension Scheme give us the benefit of tax savings and also wealth creation.
Please do not borrow to invest in tax saving products unless it is an interest free loan from friends. The tax benefit may not be as high as the interest rate charged by the bank or your friendly neighborhood financier.
A house can be a wealth only when it is paid up in full. Technically it is an asset in the banks' account till we pay out the last EMI. Please do not take up a housing loan for the apparent tax benefit that it gives; as it is highly negative in the wealth creation front. The HRA also becomes taxable if your house is in the same town as your office.
Make use of the tax breaks judiciously in the right spirit of investment and savings and not merely to avoid paying tax!