LIFE INSURANCE BASICS

What is Tax Planning?

Come March and we see people frantically stress over tax payments. This is when we get tax-related work done, like investing in tax-saving instruments, getting the right forms from insurance companies and actually filing our taxes.

Naturally, it is only then that we realise exactly how much we owe as taxes. In the face of a big tax payment, we desperately search for solutions—anything to save money! But wouldn’t it be much better to have a handle on tax long before it’s time to pay it? And wouldn’t we absolutely love to pay a little less on tax than we do?

Suppose you earn Rs 5 lakh a year and your income tax liability amounts to Rs 23,690. That is a large amount! Now suppose you invest Rs 1.5 lakh—i.e. 30% of your total income—in tax-saving instruments. You can bring down your income tax liability to Rs 10,000—a 57.7% reduction. Imagine all you can do with the money saved!

It is for this reason that you need tax planning.

So what is tax planning?

Tax planning is a logical analysis of your income and expenditure, which helps you to invest optimally so you can save money when paying taxes. Quite simply, this process enables you to think about your tax payments right at the start of the year, rather than keep it for the eleventh hour. The aim of tax planning is, thus, to manage your money in such a way that you reduce the amount you pay as tax.

Here are the steps of the tax planning process:

  1. First take into account your total income. This is simply the starting point of the process and involves doing an honest and accurate calculation of your annual and monthly income.
     
  2. See exactly how much of it is taxable. Your entire take-home pay is not taxable. Some parts of your salary, like allowances for house rent or travel, are not taxable. On the other hand, any profit you make from your investments could add to your taxable income. Thus, understanding your actual taxable income is a must.
     
  3. Avail deductions to reduce your total taxable income. This can be done through structuring your salary and planning your investments right. For example, profits from a debt fund held for over three years is taxed at 20% after indexation. Interest from a fixed deposit, on the other hand, is taxed at the same rate as your income tax. So if you fall in the 30% bracket, debt funds may be a more tax-friendly option for you.
     
  4. Lastly, invest some money in tax-saving instruments. For this, you will need to read up on Section 80 of the Income Tax Act. This mentions all tax-related rules. There are many investment options that are available for effective tax planning like Provident Public Fund (PPF), Equity Linked Saving Schemes (ELSS) or National Saving Certificates (NSC). Even your life insurance , health insurance and home loan payments can help you avail tax savings.

All you need is a simple understanding of your own income and some basic tax rules; this little effort can go a long way in ensuring your overall financial security. Unfortunately, given the hustle and bustle of everyday life, not enough of us find the time to do this. But now that you know how important it is, we hope you will find the time!