Wednesday, April 10, 2013

Prudent Tax Planning- why this should be your resolution this fiscal?

Last minute adjustments can lead to mistakes and this is so true in your tax planning. Many of you must have bought a life insurance policy to save taxes, which most probably doesn’t suit your requirements. Rather insurance policies are being sold as an instrument to avail tax deductions under section 80C on many occasions. But one must understand tax planning is just one aspect of financial planning. Any investment decision has to be consistent with your long term financial plan and any ignorance there may cost you a pretty penny later. We resolute to start something anew at the beginning of every year then why not commit to our finances at the start of a new financial year?

Approach to Tax Planning…

Your tax planning starts with estimation of your income from all sources in the whole financial year. For the purpose of calculating taxable income, income is broadly classified under five heads. 
  • Income earned as Salary
  • Income from House Property
  • Income from Business and profession
  • Capital Gains
  • Income from Other Sources
Having a right estimation of your income helps you make a use of various provisions laid in Income Tax Act, 1961 to reduce the impact of tax. As you know, investment in certain financial instruments give you benefit of reducing your tax liability. They are discussed in Section 80C of Income Tax Act. While investing in various permissible instruments, you must take into account your broad asset allocation. For example, if you are young and have just started working a few years back, you may commit more to market linked investments such as Equity Linked Savings Scheme (ELSS)provided your risk appetite is high. On the other hand, if you are a person with high risk appetite but just a couple of years away from your retirement; you should first look at less volatile options. Many people do blunders by buying market linked insurance plans in last few years of their working span. You may avoid such mistakes if you stick to your broader asset allocation.

Why asset allocation is so much important

A well devised financial plan takes a holistic view of your future financial needs. Approach to tax planning for conservative investors and aggressive investors with similar financial aspirations and same age profile may differ considerably. Asset allocation, when chalked out meticulously, may result in return optimisation. The reason why it is important to refer to your asset allocation even in tax planning is not only to optimise returns but also to utilise your resources optimally. For example, you might need life insurance and would even save taxes by paying premiums regularly but there is always a possibility that your outgo towards premium may be high vis-à-vis the risk cover you get. A Financial Plan would not only help you ascertain amount of insurance you need but also indicate a cost-effective way to get yourself covered. Asset allocation would then help you effectively deploy money that you saved.

It is noteworthy that your tax planning goes much beyond investments. It’s not only investments that help you avail tax benefits but there are some expenses too which offer tax incentives. Given below are some expenses that may save taxes for you. However, the list is not exhaustive.

Those expenses are…
  • Tuition fees paid for children’s’ education (maximum upto 2 children)
  • Interest paid on loan you have taken for your own higher education
  • Principal repayment and interest payment on housing loan
  • Premium outgo for medical insurance
  • Maintenance including medical treatment of a handicapped dependent
  • Expenditure incurred on your own medical treatment
  • Rent paid on property that is occupied for residential use
  • Leave travel allowance
  • Donations to approved trusts, funds and institutions
It is possible that you may wrongly compute your taxable income in case you are not aware of some tax provisions. Furthermore, forgetting about tax planning till March every year may make your overall portfolio of investments inefficient. As in last month of a financial year, you would not look at investment avenues that are ideal for you but may prefer those which are easily available to you. Those who have a long term financial plan in place and follow it religiously; do not have to make last minute adjustments in tax planning. It is advisable not to wait till March this financial year. Financial planning is the pre-requisite for effective tax planning.

Source :personalfn

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