For those of you, who believe that it's too soon to start thinking about tax-planning, think again! With a little over six months left for the close of the financial year, we believe this is the right time to start the annual tax-planning exercise.
Rushing around in the month of March to get invested in any investment avenue available on hand is passé.
Investments for the purpose of tax-planning (the ones eligible for deduction from gross total income under Section 80C) are no different from conventional investments.
The same degree of effort and planning needs to be 'invested' while tax-planning. Likewise, it is vital that tax-saving investments be made in line with the investor's risk profile; also the tax-saving portfolio should be a well-diversified one.
In the present investment scenario, investors have a wide range of avenues to choose from while conducting their tax-planning exercise. Everything from market-linked instruments like tax-saving funds to small savings schemes like National Savings Certificate (NSC) and Public Provident Fund (PPF) to 5-year bank fixed deposits (FDs), among others vie for the investor's attention. A judicious mix of the above in the right proportion is what the investor must target.
We present a 4-step strategy for conducting the tax-planning exercise.
1. Review your existing investments
The tax-planning exercise can commence with a review of the existing tax-saving investments. For example, PPF accounts and insurance policies/ULIPs (unit linked insurance plans) which run over longer time frames should be put under the scanner.
Investors should enlist the services of an investment advisor and review the utility of such investment avenues. If any avenue has ceased to add value to the portfolio or is a mismatch, then the same should be done away with.
For example, the only insurance instrument in a moderate risk-taking investor's portfolio could be a ULIP (with a nominal sum assured) which invests its entire corpus in equities.
In such a scenario, the investor stands the risk of being underinsured and also being invested in an avenue which doesn't match his risk profile. Such an investor can be a candidate for a portfolio review.
2. Provide for the fixed commitments
The next step can be to compute what the fixed commitments are. For example, for salaried individuals, a statutory deduction like contribution towards Employees Provident Fund (EPF), which is also eligible for Section 80C benefits would qualify as a fixed commitment.
Similarly, premium payments for on-going insurance policies or contributions towards existing PPF accounts would fall under the same category.
The intention is to determine, what portion of the Section 80C deduction (Rs 100,000), the investor can freely invest. Consider an assessee who is required to invest Rs 100,000 for the purpose of tax-planning; he holds an endowment policy wherein the annual premium is Rs 35,000.
In such a scenario, the investible surplus for the purpose of tax-planning would be only Rs 65,000 (Rs 100,000 less Rs 35,000).
3. Get the right allocation
Drawing out a detailed investment plan for the purpose of tax-planning is the next step. The investment advisor should be actively involved at this stage. The investor's risk appetite will play a vital role in determining the allocation to each investment avenue.
Broadly speaking, assured return avenues like NSC and FDs will dominate a moderate risk-taking investor's tax-planning portfolio. Conversely for risk-taking investors, tax-saving funds and ULIPs should be staple diet.
4. Execute the investment plan
Executing the investment plan would be the final step. If tax-saving funds feature in the plan, starting a systematic investment plan (SIP) which runs over the ensuing 6-month period could be a good idea.
By investing over a longer time frame, investors can minimise the risk of mistiming the market. Conversely, investments in assured return schemes like PPF should also be made well-ahead of the due date. Apart from ensuring that the necessary paper work is completed on time, it would also help the PPF investments clock higher returns as compared to deposits made just prior to the due date.
To state that investments made for the purpose of tax-planning can have a huge impact on the overall finances would be an understatement of sorts.
An example will help us better understand this. Rs 100,000 invested annually, over a 15-year period with a return of 10% per annum (considering that assured return schemes offer a return of 8% per annum, this assumption for the composite portfolio is a realistic one), would amount to approximately Rs 3,177,200 on maturity. Few would dispute the fact that there is merit in giving the tax-planning exercise due thought and effort.
Our advice for investors - commence the tax-planning planning exercise now and you will be placed to utilise the month of March for something more constructive than worrying about investments.
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