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Fix your tax plans right here, right now
July, 31st 2006

This is the right time to start your tax planning and get your financial life in order. No, we are not referring to the last-minute rush that is currently on to file returns for fiscal 05-06. We, at ET Big Bucks, are now looking ahead at the next year because starting early in the year is half the job done. This means that it is time to get ready and do your tax planning for the financial year 06-07 right now.

Starting early gives you enough time to select investment options which actually suit you. Though tax planning can be undertaken in various ways, you need time and thought to ensure that it is distinctive and appropriate for your needs.

One of the major problems which dogs the overall tax planning process is that everyone seems to go for the same routes and the same investments. In many cases, people actually put more money than is actually required in tax-saving instruments.

Therefore, they actually miss out on investing in other avenues where their money could have been put to better use and would have earned them higher returns. Such errors of judgment occur because people forget that each individuals needs are different and investment decisions have to be taken keeping this maxim in mind.

Before discussing and selecting various tax-saving instruments, lets first take a look at various benefits available to an individual. While there are a whole lot of deductions that are available, we shall focus on the main benefits available to the salaried class.

A deduction is the amount that is reduced from the total income so that the taxable income of the individual comes down. The tax is then calculated on the net income.

A housing loan is a big tax break route because under the current norms, interest up to a sum of Rs 1.5 lakh paid on the repayment of the loan when the house is used for self occupation, is allowed as a deduction from the income of the individual.

In addition, the capital repaid during the year qualifies under the overall limit of Rs 1 lakh, which is available under Section 80C of the Income Tax Act.

Section 80C is quite extensive and offers individuals several options in terms of investment. The total benefit available to the individual under Section 80C, along with the benefit for paying the premium of a pension plan to an insurance company under Section 80CCC, should not exceed Rs 1 lakh. 
Hence, the investor should carefully choose the options under this route. The various sub-routes available here include contributing to provident fund (PF), investing in public provident fund (PPF), buying National Savings Certificate (NSC), investing in equity-linked savings schemes (ELSS), paying life insurance premium and investing in pension schemes of mutual funds.

In addition, any sum paid as premium for medical insurance is allowed as a deduction up to Rs 10,000 under Section 80D. This ensures that medical coverage also gets a tax benefit. Also, any donations made during the year to charitable institutions, eligible for Section 80G benefits, will also qualify for a deduction at specified rates and subject to specific limits.

So, when an individual is planning his/her investment for tax purposes, he/she must remember that the benefits of a housing loan, medical insurance and even donations can be availed only if these items are present in his/her portfolio.

All decisions related to the use of these benefits are separate decisions in themselves, which are based on a number of factors that must be considered. For example, medical insurance by an individual will depend upon several factors, including the coverage given by the employer and the nature of such a scheme.

That brings us to the most important component of the tax-saving process using the Rs 1-lakh investment benefit. So, how should individuals avail the maximum benefit from this route and also ensure that it meets their individual needs?

One of the several ways in which an individual can go about doing this is to check his or her portfolio and decide whether he/she wants to use this tax-benefit route as an investment benefit, or position it as an expense measure.

Lets see it this way: If this limit is wholly made up of insurance premium and tuition fees of children, then it is not adding to any investment assets, which could be used a few years down the line. Here, the insurance cover offers protection to the dependents in the family and works as a long-term investment.

Further, the Rs 1-lakh composition can be broken into the fixed part and the other part, which has to be planned for. Items such as insurance premium and even repayment of capital on a housing loan, will be taking place on a continuous basis, so investors will hardly have to do any additional work on this aspect. On the other hand, the remaining part, which requires selecting a list of investments, has to be adequately planned and provided for.

When planning for the remaining investment, you must clearly decide whether you want to play it safe or take on an aggressive stance. The investment break-up of the play safe individual will look something like this there will be some PF contribution at the workplace and the remaining limit will be made up of investment in PPF, bank deposits and NSCs.

All these are pure debt instruments and, hence, there is little risk of capital loss. The decision to select these instruments solely depends on the returns generated by them.

The aggressive investor, on the other hand, would ensure that the contribution to PPF is shored up by investment in equity-linked savings schemes (ELSS) of a mutual fund. The pension schemes of mutual funds are also balanced in nature and, so have an equity component.

The equity component poses a risk, but there is also the chance that if parked long term, such an investment could yield higher returns vis--vis other debt instruments. The composition of these items will have to be done individually after assessing ones own risk.

The best way to go about is to invest regularly on a monthly basis to reduce the burden of investing in the last month of the year. If you want to be an aggressive investor and opt for schemes like ELSS, then investing on a regular basis through a systematic investment plan (SIP) is an absolute must.

And yes, there is no reason why the same approach cannot be adopted for investments in a PPF or NSC, as they allow the flexibility of making investment in parts. So, go only for those investment options that are comfortable to pay for, allow for the maximum tax benefits and also help divert additional sums into other investments.

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