Tax planning is one of the most significant things in a person’s work life. As soon as a person starts doing a job, he needs to plan taxes. Generally, most people are unable to look objectively at tax planning. They tend to invest in tax saving avenues quite mechanically.
We need to realize that tax planning is part and parcel of our financial planning process. If we plan thoughtfully, then only we will be able to accomplish all our financial targets and goals. The following are the deadliest but very common tax planning mistakes that you need to avoid at all costs. Let’s have a look at all of them:
Investing in tax saving instruments in the last quarter can have severe impacts. You will lose the amount of interest/returns that you could have earned in the initial 9-10 months of the year. If you are investing an amount, suppose INR 1- 1.5 lakhs, this initial returns will be quite profitable. Suppose the rate of interest is 10% per annum, then for ten months and Rs 1 lakh investment, you will gain the interest of Rs 8,333. It is very easy to calculate that you will lose around Rs 5-8 lakhs if you keep on waiting till the last quarter for the tax-saving investments.
Some investors prefer to invest a part of their annual bonus in the tax-saving investments for the next year. However, many investors do not have enough investible funds in the very beginning of the financial year. So, you can invest in a mutual fund equity-linked savings scheme or ELSS, by taking the help of SIPs or Systematic Investment Plans. SIPs allow you to invest from your regular savings monthly. This technique will help you gain the monthly returns as well as benefit in the long run.
It is very common among investors to postpone tax planning until the end of the year. Some of the investors do not even begin with their tax planning until the time their employers ask for the submission of Section 80C, investment proofs, etc. for the TDS purposes. An investor does not have much time to think about the investments because of the deadlines of their employers. They cannot decide well and link these investments to their financial targets. Most of the time, such hasty decisions result in the regret of the investor in a later period.
The salaried investors are well aware of their fixed salary at the beginning of the financial year. They also know the interest that they will receive from the existing bank account deposits. Some assumptions can also be made about the bonus and incentives. You can take help from all these assumptions and calculations and start planning in April itself. You will get enough time to think and choose the right investment option that caters to all your needs and requirements in the long run.
It is very important to understand that tax planning is not just about tax savings. You must link it to your financial targets and goals. You must choose schemes that not only help in tax saving but also provides assistance in the accomplishments of financial goals. Several 80C investment schemes have different return/risk profiles. You should go through all the options and choose one according to your risk appetite and financial goals.
It is well-known that all the tax-saving investments are meant for the long term. According to historical data, equity is the most suitable asset class in the long term. Investors who have moderately high to high-risk appetites, mutual fund ELSS is the best wealth creation option. It caters to all your long term financial targets.
This is one of the most common issues that we get to see among the investors. No doubt, life insurance is the most significant financial need of any family. If there is a lack of adequate life insurance cover, then your family may face considerable financial risk in case of an unfortunate death. At the same time, it is necessary to understand that tax investments or savings are quite different from life insurance.
You must know that the premiums of life insurance come under the tax savings option, according to to0 Section 80C. You should never let your tax-saving priorities guide you in your life insurance decisions. This may land you in a situation where you buy the wrong insurance product. You may also get a very lower rate of returns.
For instance, if you buy an insurance cover worth Rs 1 crore for a tenure of 20 years, and the annual premium ranges between Ra 10,000 - 14,000, you will gain no survival benefits or ROI. In the case of an endowment plan, the annual premium may be around Rs 50,000 for 20 years and a sum of Rs 10, 00,000. As the policy gets matured, you will receive the sum as well as the bonus.
If you combine investment perspective and tax savings, then you will find the endowment option more beneficial. But if you separate these two priorities, then choosing the endowment plan will be a wrong decision. Your returns will be sub-optimal as compared to other 80C investment instruments. Also, you will be severely underinsured.
If you are investing in tax saving options, then this does not necessarily mean that you have to lock your money for several years. Although it is advisable to invest on a long term basis, at the same time, it is equally essential to think about the liquidity profile of the asset. You never know when you need money on an urgent basis due to some unforeseen event. Hence, it is extremely important to be thoughtful about tax planning. While making investment decisions, one must also consider the factor of liquidity.
As we told earlier, tax planning is not just about tax savings. While doing tax planning, one must also consider the consequences, such as maturity amounts. Taxes may take a huge chunk of your returns. So, it is necessary to ensure that you invest in a tax-efficient scheme. This will help you in gaining the best returns for your financial targets and goals.
Budget 2020 and the tax implications:
As we all know, February 1st was the D-Day when the Finance Minister of India presented the Union Budget 2020 in the parliament. A new income tax regime has been introduced by the government. It has 7 income tax slabs. We can see no change in the income tax exemptions for incomes up to Rs 5 lakh. If we have a look at the incomes between Rs 5 lakh to Rs 10 lakh, then we will notice that there is a considerable drop in the tax rates. But the new tax regime does not allow you to choose these exemption options.
The government has removed about 70 tax exemptions from the new tax regime. These are LTA, HRA, Section 80C, home loan interest, standard deduction, medical insurance premium, education loan interest, and savings bank interest, and so on. The new tax regime does not allow one to opt for these tax exemptions. So, each investor has to calculate and plan well about the new tax regime and compare it with the current ones. Only then, he will be able to take the correct decision. Also, an investor should keep in mind that the new tax regime is completely optional. So, it is up to the investor if he wants to continue with the older tax regime or move forward with the new one.
There is also a change in dividend taxation. And this is for sure, going to affect the investors. We have seen an abolition of the Dividend Distribution Tax (DDT). Companies are liable for these before paying dividends to their shareholders. The removal of DDT is also applicable in the case of mutual fund schemes. Now, it is necessary to understand the implications of this alteration. Now the investors will get more dividends. But the fact that is worth noticing is that from the next financial year onwards, these dividends will be a part of your income and hence taxable.
At present, the Dividend Distribution Tax for equity funds is about 10%. If the income tax slab rate is less than 10%, then you will be able to reap the benefit of this situation. However, if you have a higher income, then you have to pay more taxes. In the case of non-equity funds, the DDT is about 29.12%. Those who have income tax slab less than 30% will benefit from this change. The investors who have a higher income tax slab will find the change quite difficult.
We request you to take your financial planning sincerely. Try to make it your priority. You can take the help of the various points that we have discussed here. Also, do not forget to consult your financial advisor.