Don’t just do tax-saving, start tax-planning

It’s that time of the year when you should begin your tax-planning exercise. Towards this end, this week’s article reiterates our annual tax-planning tips.

Most taxpayers tend to defer their tax-saving investments till March and then rush into putting their money into something with the sole objective of saving tax for the year.

As long as investing in the chosen instrument results in getting the tax deduction, their immediate purpose is solved. The instrument of choice is more often than not something recommended by a colleague or promoted heavily in the media.

And if you are senior management or a businessman, then you have already been anointed a high networth individual (HNI) and assigned a ‘relationship manager’ whose sole purpose in life is to force-feed you the latest flavours of the season. As a result, while you end up saving on tax, there isn’t any tax-planning.

Take for example Section 80C of the Income Tax Act, which is anyway the only meaningful deduction left. Under this section, as most of you would know, any investment up to Rs 1 lakh made in certain specified instruments can be reduced from your taxable income.

There is a long list of eligible investments including an employee’s provident fund contribution, tuition fees paid for children, principal portion of housing loan installments, investments made in Public Provident Fund (PPF), equity linked savings scheme (ELSS), National Savings Certificates (NSC), Senior Citizen Savings Scheme, Post Office term deposits, life insurance premiums paid, etc.

If you think about it, these are the very investments that one makes anyway and therefore are no different than one’s regular investments. All you need to ensure is that these are integrated into the larger picture in line with one’s risk profile and financial goals.

So how should an investor choose from amongst the various choices available? Here’s what you should do.

Using Sec 80C optimally
First take into account the mandatory payments such as provident fund, housing loan EMIs and tuition fees if applicable. Reduce the total amount spent from the Rs 1 lakh limit. Distribute the balance in a combination of ELSS and PPF.

If you are relatively young and just starting out, put 70% into ELSS and 30% into PPF. As you advance, lower the ELSS and increase the PPF, eventually reaching a 30% ELSS and 70% PPF combination.

Why PPF? Well, PPF is the best fixed income investment that you can make. An annual contribution of Rs 70,000 will get you around Rs 32 lakh in 20 years. Look at it as a fund for the education needs of your children. If your children don’t need it, get your spouse to invest too and you would have a retirement fund ready.

An ELSS is nothing but an equity mutual fund that offers a tax deduction. On account of the tax deduction, there is a lock-in of three years on the investment. This lock-in enables the fund manager to take long-term calls on the market, which is essential for any equity investment.

ELSS investments are the most preferable way to build long-term wealth. However, this investment comes along with the inherent risk of the stock market. Hence the suggestion that the proportion of ELSS in your total tax-saving investment should come down as age advances and the risk taking ability declines.

Recycling old investments
Take the case of one of my friends, Amit, who is into web design. Amit’s lament was that he had over Rs 5 lakh in receivables but customers in general were holding out for longer credit periods.

Since our income-tax laws tax income on accrual and not on receipt, this means he has to pay the tax on the Rs 5 lakh not yet received. He was having difficulty in arranging funds required to pay his employees for the month, so to keep anything aside for tax-saving was a long shot.

In such cases, one can use another tax-planning tool. We call it recycling. Amit can simply withdraw an earlier investment (say from ELSS or PPF) and redeposit the money, even in the very same instrument. He will get the tax deduction for no additional outlay —- in other words, his savings remain the same, but without investing a rupee, he can avail of the 31% tax-saving.

Last but not the least
As mentioned earlier, your tax-saving investments are no different than your regular investments. Consequently, the basic principles of investing remain the same for both sets of investments.

Therefore, next year, instead of waiting till the fag end, start by investing in tax-saving avenues in the very beginning of the financial year, even on the 1st of April. Doing so has a two fold advantage.

First, these investments would earn a return from the beginning of the financial year (April-March). Secondly, it obviates a situation where you may end up simply not having the lump sum required at one go for 100% tax-saving.

Realise that there is no compulsion to make tax-saving investments towards the end of the year. A more efficient strategy is to invest throughout the year in a staggered manner such that by the time the year comes to an end; full advantage of the tax-saving opportunity is taken. And don’t worry about how much or how little you save each month. As Benjamin Franklin has so succinctly put it, “A penny saved is a dollar earned!”

Source: http://www.dnaindia.com/money/column_don-t-just-do-tax-saving-start-tax-planning_1478185

Now you can SIP into New Pension System, too

The New Pension System (NPS), as the New Pension Scheme is now known, can henceforth be subscribed to through the systematic investment plan (SIP) route.

ICICdirect.com on Monday launched the facility on its broking site.

Under the facility, a customer can subscribe to NPS, select a fund manager of his choice, view and access registration details and also place contributions online.

One can start an SIP for as low as Rs500 a month and also track the net asset values online. ICICIdirect will charge Rs40 for opening an account and Rs20 for every subsequent transaction.

The launch of SIP facility on the NPS is expected to boost its subscriber base.

“The total corpus of NPS is Rs7,000 crore, whereas collections from the unorganised sector under the scheme is only Rs40 crore. The Bajpai Committee report is expected by January 2011, which will help in studying as to why the contributions from the unorganised sector are low,” Yogesh Agarwal, chairman, Pension Fund Regulatory and Development Authority said.

NPS is managed by seven pension fund managers, namely, SBI Life, ICICI Prudential, Reliance Life Insurance, IDFC Pension Fund, Kotak Life Insurance, UTI and LIC, which is for the government.

Currently, only Tier I NPS accounts are available on ICICIdirect, wherein account holders cannot withdraw money up to the age of 60. Tier II, to be launched in a few months, will offer the facility to withdraw the money as many times as a customer wishes to. But unless you have invested in Tier I, you cannot opt for Tier II account.

Some experts though continue to have reservations about the NPS.

“A balanced fund looks more attractive. In the NPS, information is not easily available. Also, if it is 50% equity and 50% debt and the returns are taxable, I won’t recommend the scheme. If a person is ready to wait for the long term, he can earn better returns in mutual funds. Return on the NPS is around 11%, whereas a balanced fund would easily give 12% return in the long run and it is more tax-efficient,” said Rajendra Dhulla, financial planner, partner with Pratham Services.

The government had announced Swavalamban Scheme in the Union Budget 2010-11, to which the government will be contributing Rs1,000 per NPS account each year for the next three years. The benefit will be available to persons who join the NPS with a minimum contribution of Rs1,000 and maximum contribution of Rs12,000 per annum. In order to open an NPS account, a minimum contribution of Rs6,000 per annum is mandatory, whereas in case of NPS Lite, the minimum amount is Rs1,000 per annum.

Source: http://www.dnaindia.com/money/report_now-you-can-sip-into-new-pension-system-too_1477697