Many people invest only to save tax. They don’t check whether the investment can yield good returns. By doing this, they are merely maximising tax-saving. But the flipside is that they waste an opportunity to build their wealth.
Instead, what one should do is to optimise their tax-saving options.
This article will explain what optimisation of tax-saving means and how you can do it. But before we dive into it, let’s look at what people generally do to maximise tax-savings. This will provide a contrast for better understanding.
What people usually do
People try to maximise tax-saving by using deductions and exemptions allowed under the Income Tax Act.
• They take help of Employer’s Provident Fund, children’s tuition fees, insurance premium etc. to save tax, thanks to Section 80C of the Income Tax Act.
• They also buy a high-value health insurance plan to get tax breaks under Section 80D.
• They invest in National Pension Scheme (NPS) only because it provides an additional Rs 50,000 tax benefit.
• They give money to charities because donations are tax-exempt.
• They also claim additional tax exemption if they are repaying their home loan. This is how they get tax breaks for repaying the debt:
a. They save tax up to Rs 1.5 lakh if they are repaying the principal component of the loan. If one is a first-time home
owner,the tax exemption is up to Rs 2 lakh. However, in this case, the property should be less than Rs 50 lakh and the loan
amount should be less than Rs 35 lakh.
b. Furthermore, they claim tax exemption for paying the interest component of the loan. The Income Tax Act allows tax
deduction of up to Rs 2 lakh.
This is what people usually do to save tax. But this isn’t how it should be done.
If you follow a few steps, you can optimise your taxes and also invest as per your financial goals. After all, you should invest to increase your money. Saving tax should be a by-product, not the primary focus, of investment planning.
What should be done
• House rent allowance (HRA), Leave Travel Allowance (LTA), meal allowance, medical allowance, etc. are a part of your salary. These components are tax-exempt. So, use these exemptions to reduce your taxable income.
• You should choose a tax-saving investment after weighing the post-tax returns. You also need to check whether the investment is helping you achieve your financial goals. If not, you are merely frittering away your money. Remember, investments should primarily build wealth. Saving tax is secondary. This is what optimisation is all about.
Some important points to note:
• While optimising, consider the hidden aspects of taxation as well. For example, opting for the dividend option in debt mutual funds can give you tax-free dividends. But, the dividend amount will attract DDT (dividend distribution tax) of about 28.84% to be paid by the Fund. So, keeping in mind the net tax rate, it could be more beneficial for a person in the 30% tax slab. After all, the others would otherwise pay a lower income tax of 5-20%.
• The National Pension Scheme gives an extra tax deduction of Rs 50,000. But, at the time of retirement, 40% of the saved money needs to be converted into annuity (a fixed amount paid from time to time to retirees). This may not be tax-efficient because the annuity you receive will be taxed. Therefore, you should look for investments where the returns are also tax-free.
These are some of the tricks of the trade when it comes to saving taxes. If you want to learn more, you can take help of IndiaNivesh.
What we can do for you
1) IndiaNivesh Securities Ltd. is a 360-degree financial planning services. We have expertise in investing and tax-planning.
2) We have extremely scientific and well-researched processes for product selection, which are unbiased and algorithm-oriented
3) We give utmost importance to your risk profile and asset allocation
Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.