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How Should Risk Takers Go About Their Tax Planning - Outside View by PersonalFN

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How Should Risk Takers Go About Their Tax Planning
Jan 14, 2016

"It's January, have you planned your taxes?" quipped Mr. Planner to Mr. Investor. "Abhi to bahot time baki hain, March mein dekhenge" (There is loads of time in hand and we will start planning in March), replied Mr. Investor.

This is the same story, repeated year after year, by most individuals. We start planning for our taxes when there is little time left to put a constructive plan in place. Most of the time tax planning is done in a hurry, just to meet the March 31, deadline. Seldom do investors consider if the Tax Planning decision is in sync with their overall financial goals and objectives.

Moreover, in their hurry to save tax, people miss out on options that are not only tax efficient but also help in generating suitable returns. They even fail to optimally utilise all options available for tax saving.

You see for prudent tax planning, here are parameters you must consider:

  • Age: Your age and the tenure of your investment play a vital role in your asset allocation. The younger you are, the more risk you can take and vice-a-versa.
  • Income: Similarly, if your income is high, your willingness to take risk is high. This can work in your favour, as you have sufficient annual Gross Total Income (GTI) that allows you to park more money towards market-linked tax saving investment instruments, to generate higher returns and creating a good corpus for your financial goal(s).
  • Financial goals: The financial goals that one sets in life, also influences the tax planning exercise.
  • Risk Appetite: Your willingness to take risks which is a function of your age, income, expenses, and nearness to goal is also an important determinant while doing your tax planning exercise.

The instruments available for tax planning:

There are a host of tax saving investment instruments. They can be classified as those offering market-linked returns and those offering a fixed rate of return. The former serves risk takers, while the latter is suitable for those who are risk-averse. So, you ought to select tax saving investment instruments which suit your risk profile.

Let's see the tax saving investment instruments available for risk takers...

If you are young, income is substantial, and therefore your willingness to take risk is high (seeing that your financial goals are far ahead), market-linked investment instruments would be the most appropriate. These instruments earn variable returns which are can potentially help you clock better a real rate of return. Following are the market linked tax saving instruments that are available for investment under section 80C.

  1. Equity Linked Savings Scheme (ELSS):

    These are mutual fund schemes that are 100% diversified equity funds providing tax saving benefits. And these are popularly known as Tax Saving Mutual Funds or ELSS. A distinguishing feature about them is that they are subject to a compulsory lock-in period of usually three years, but the minimum application amount in most of them is as little as Rs 500, with no upper limit.

    Deduction: The maximum tax benefit that an Individual or HUF can enjoy under Section 80C is Rs 1.50 lakh p.a. Moreover, if you make any long term gains at the time of exit, any time after the end of the lock-in period; you will not have to pay any Long Term Capital Gains Tax (LTCG).
  2. Pension Funds:

    Pension funds offered by mutual funds can not only be used for tax planning, but are also an effective instrument to plan for a blissful retired life. Pension funds allocate 60% money into debt and remaining in equity. At the vesting age, you can opt for regular pension or systematically withdraw the units.

    Deduction: The amount invested in pension funds qualifies for deduction under Section 80C, subject to a maximum limit of Rs 1.50 lakh p.a.
  3. Unit Linked Insurance Plans (ULIPS):

    These are typically insurance-cum-investment plans which enable you to invest in equity and/or debt instruments depending on what suits you as per your age, income, risk profile, and financial goals. All you simply need to do is, select the allocation option provided by the insurance company offering such a plan.

    Generally, they are classified as "aggressive" (invests in equity), "moderate or balanced" (invests in debt as well as equity), and "conservative" (invests purely in debt instruments).

    These policies have a minimum 5-year lock-in period, and also have a minimum premium paying term of 5 years. The overall term of the policy varies from product to product.

    Deduction: The premium you pay for your ULIP is eligible for tax benefit, subject to the maximum eligible amount of Rs 1.50 lakh p.a. as available under Section 80C. Moreover, a positive point is that at maturity the amount you or your beneficiary receives is tax free (exempt) as per the provisions of Section 10(10D) of the Income Tax Act.
  4. National Pension Scheme (NPS):

    National Pension System, available earlier only for Government employees, on May 1, 2009 was also introduced for people in the unorganised (private) sector, as there was a need for higher participation in pension contribution (through this product).

    For NPS, if you (eligibility age: from 18 years to 60 years) belong to the unorganised sector (i.e. private sector); the contributions you make towards the scheme are voluntary, and you can invest in either the Tier I or Tier II account.

    Deduction: Those who are salaried employees may claim deduction under Section 80C, for upto Rs 1.50 lakh for their own contributions towards NPS account. In addition to this, a deduction can be claimed under Section 80CCD, if there is any contribution made by the employer; upto 10% of their salary (for this purpose, salary construes as Basic Salary plus Dearness Allowance). It is noteworthy that the deduction under Section 80CCD can be claimed over and above the permissible deductions under Section 80C (Note: It is only if the employer contributes to employee for NPS - Section 80 CCD is applicable).

In our ensuing edition, we will explain tax saving investment instruments for risk-averse investor that yield an assured return; so tuned.

To know more about how to plan your taxes prudently, download our Tax Planning Guide (2016 edition). It's free!

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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