During the FY 2020 tax declaration season, we tried to present a simple guide for efficient tax planning for sincere tax paying individuals through a comprehensive blog. This guide tried to explain what exactly is tax planning according to us and the different alternatives individuals have as investments that reduce the income tax bill. This blogpost will try to focus on how investors should look at tax saving investments as a part of their portfolio and also will try to highlight other types of taxes for investors.
PS: Read our old blog over here.
Tax planning as a part of investors’ financial goals:
All of us are aware that the benefit of saving our tax bill comes with an asterisk of very low liquidity on our tax saving investments under the section 80C of Income tax. Putting aside the liquidity aspect for some time, these investments have different degrees of risk associated with them. For example, Equity Linked Savings Scheme (ELSS Mutual Funds) have a three-year lock-in period with high-risk structure, but a tax saving bank fixed deposit has a five-year lock-in period with practically zero risk structure.
Every investor should have a well sorted list of financial goals based on time periods and priorities and any 80-C investments as a part of our tax planning activity should be tagged to one of our financial goals. The first key aspect here is to map the time period of the financial goal to the lock in period of the tax saving investment. The second key aspect is to map the risk profile of our financial goals to the risk profile of the tax saving investment.
If an investor has three financial goals with different time periods (for example 3 years , 5 years and 15 years) then the current year’s tax saving investment should be mapped to the appropriate financial goal considering its lock in period (ELSS 3 years, tax saving FD 5 years, PPF 15 years). Financial goals have varied levels of risk capacity and profiles just like various tax saving investments. Wealth Appreciation as a financial goal has an above average to high risk profile depending on the investor. ELSS (Equity Linked Savings Scheme) can be a part of this financial goal as an equity asset class component rather than having tax saving as a stand-alone financial goal.
Similarly, even though an emergency fund has very low risk capacity matching the risk profile of a tax saving fixed deposit, it would not be the right thing to include this investment as a part of our emergency fund pool due to its no liquidity defeating its purpose.
We should all make sure we handle our other aspects of tax planning as well like checking capital gains, dividend income, interest income (included in income tax slabs), HUF (Hindu Undivided Family) filing, rental income and all applicable GST tax filing this tax season and have a happy and healthy financial profile.
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