How Tax Planning can help you Create Wealth
Happyness Factory is a Goal Based Planning platform. We aim to spread financial literacy and help people make sound financial decisions.
19 Feb, 2018
It’s no secret that most people perceive tax planning as a nuisance they are forced to deal with. Every year, this headache arises due to illiteracy regarding all available options, confusion about the process and a haphazard, last minute attempt at tax planning.
While planning their taxes, people typically exhibit behaviour patterns.
- They adopt an ad hoc approach to tax planning, wherein investments are mostly made in the last three months of the financial year i.e. from January to March.
- Most people’s entire purpose behind planning their taxes is to save tax and stop their employer from making excessive tax deductions. Thus, accounting for their current situation, people only concentrate on their immediate goal, applying no forethought towards planning for the future.
- By adopting a hasty approach, people tend to gravitate towards tax saving options like life insurance policies or PPF. This is generally done after accounting for EPF deductions, if applicable. While EPF and other retirement benefits definitely contribute towards leading a comfortable retired life, they might not always be sufficient avenues of income.
What is the better way to plan tax effectively?
For most people, saving for tax is the only form of investments or savings they have. Especially in such a case, making the most of this process is crucial.
Looking at tax planning in isolation isn’t a good idea. For the best possible results, it is imperative that tax planning be viewed within the broader framework of Financial Planning. We’re all familiar with the HR departments in our workplaces pressurizing us file our tax returns, come January. Rather than joining the mad scramble during this period, a more effective method would be to begin the planning process at the start of the year.
Tax planning should ideally be done with a two-pronged goal in mind. In addition to saving tax in the present, look to use tax saving as a wealth creation device for the future. Keeping long term goals in mind, while planning in the present is the hallmark of good financial planning.
Let’s take the example of retirement. A financially secure and comfortable retirement is a long-term goal for most people and must ideally be linked to tax saving. To understand how, let’s take the example of Arjun (35 years). He wants to retire at the age of 60 and has decided that he will need Rs. 50,000 per month (in today’s time), to lead a comfortable retired life. Accounting for inflation, Arjun will have to create a corpus of Rs. 5.63 crores to live comfortably till the age of 85.
With this in mind, he makes an annual investment of Rs. 60,000 towards tax saving. His tax saving investments itself, helps him to accumulate Rs.1.03 Crore (which is about 18% of the need).
|Investment Type||Risk||Pre-Tax Returns
|Post-Tax Returns p.a.||Lock In Period
|Annual Investment Amount (Rs.)||Taxability||Accumulated Corpus (Rs.)|
|Fixed Deposits||No Market Risk||7.50%||5.25%||5||60,000||Taxable||31 Lakh|
|PPF||No Market Risk||7.60%||7.60%||15||60,000||Tax free||44 Lakh|
|ULIPs*||Market Risk||10.00%||10.00%||5||60,000||Tax free||65 Lakh|
|ELSS||Market Risk||14.00%||12.90%||3||60,000||Taxable||1.03 Crore|
*Average returns from a ULIP Policy pre expense is 14% p.a. & as per IRDA guidelines maximum expenses of 4% hence, we have considered returns on 11% p.a.
**Market Risk – Investment Value fluctuates
While, PPF, EPF, life insurance policies, etc. are all effective instruments of saving tax, they are not great wealth building tools. To build wealth for a long-term purpose, a more beneficial option is investing in Equity Linked Saving Schemes (ELSS).
The planning process involves making decisions about future needs in the present. People assume that this process will be complicated, when in fact all they need to do, is gain as much literacy about the subject as they can, make informed decisions and avoid procrastinating. If these steps are followed, it’s quite easy to save tax, while building wealth in the long run.