What is the importance of tax planning?
Introduction
Going by the common saying, “The art is not in making money, but in making money work for us." There is no denying of the fact that investing is utmost important for accumulating huge fund corpus in order to retire peacefully. What can be better than mutual funds which diversify the portfolio and generate consistently higher effective returns for investors?
Investors may have different financial goals which are aligned to meet their needs. Therefore, mutual funds are best avenues for investing as they offer a plethora of products customized to meet each individual’s financial needs. It is credible to think that no one can achieve their goals unless they have proper planning at their perusal. A comprehensive planning is mandatory to attain your objectives and following up with the planning at the right time is another crucial step which will take you closer to your financial goals. Tax planning is a part of financial planning which helps investors to align their objectives by considering the impact of taxes on their income.
In this article, we will closely look at the importance of goal setting and tax planning in investing world.
What is tax planning?
People often confuse tax planning with filing of ITR and paying taxes on time but that is not tax planning. Tax planning is about thinking of legal ways to minimize your taxable income by taking advantages of exemptions, deductions, and exclusions available. Investors get more disposable income in their hands if they follow a proper strategy on tax planning. People earn money by slogging in offices so they would be really elated if they could save some of this money through tax planning. After all, no one wants to pay higher taxes.
Tax planning plays a significant role in maximizing the wealth by minimizing the burden of taxes. Setting a goal is the first step in tax planning because your planning will revolve around that specific financial goal which you want to achieve and that could be a short term or long-term financial goal.
How does setting of a goal helps in tax planning?
It is not easy to set a financial goal as the process has its own difficulties. People often procrastinate and avoid setting a goal and end up following herd mentality. Sometimes, people could not follow up with their goals due to changes in their financial circumstances. The lack of financial discipline costs them heavily due to loss of the benefits from compounding. People who sincerely want to set goals cannot get access to holistic guidance which creates hurdle for them in utilizing their financial resources to the fullest. Financial advisor can play a significant role in helping you out through the goal setting process. Therefore, setting a goal requires in-depth analysis of revenue and expenditures in order to chalk out an efficient plan for wealth creation.
Identifying a financial goal is the cornerstone for tax planning in order to minimize taxable income. Once goal is identified, then investors can look for the options that come with tax benefits so that investors can confidently invest and take the advantage of more disposable income. Investors should keep in mind that goals should be SMART (Specific, Measurable, Achievable, Realistic and Time-bound) because a smart goal is most likely to be achievable. It is also a good practice to stick to your goal instead of making frequent changes since discipline in financial goals is required to appreciate your wealth.
There are many options for availing tax benefits while investing through mutual funds but the best is investing through ELSS i.e., Equity Linked Savings Scheme. ELSS belongs to equity category of mutual funds. Investors are eligible to get tax exemptions under section 80C of income tax while choosing mutual funds schemes as an investment tool. Under ELSS, investors can save up to ₹ 1,50,000 from taxes. These schemes come with a lock-in period of 3 years. Investors can invest either through lump sum or in SIP mode.
Comparing ELSS with other tax saving options like National Saving Certificates whose returns lies in the bracket of 6% to 8% with a lock in period of 5 years and returns are taxed. While ELSS returns are higher (10% - 12%) with money locked in for only three years and these are partially taxed since returns amount up to ₹ 1,00,000 are exempted. Therefore, ELSS funds are the best if you want to minimize your taxable income. If you want to know more about ELSS and tax saving please feel free to follow the link https://sipfund.com/blog/How-to-save-tax-with-Mutual-Funds.html
Some of the best ELSS tax saver funds are mentioned below with their historic returns:
| Fund Name | 1 Year Return | 3 Year Return | 5 Year Return |
|---|---|---|---|
| Axis Long Term Equity Fund | 19.50% | 15.43% | 16.77% |
| DSP Tax Saver Fund | 24.64% | 11.84% | 17.66% |
| ICICI Prudential Long-Term Equity Fund | 24.38% | 11.52% | 14.26% |
| Invesco India Tax Plan | 22.67% | 12.49% | 16.60% |
| Mirae Asset Tax Saver Fund | 33.97% | 15.89% | 22.82% |
So, in case you are planning for a goal of higher education of your child in say 3-4 years, and you are doing a SIP to achieve that goal, it would be wise to do that SIP in the ELSS fund, so it not only serves the purpose of achieving that goal, but it also helps in saving the tax under 80C. This way both the tax planning and the goal planning is achieved by one investment.
Similarly, every year if you are doing Tax planning under ELSS or other tax saving schemes and wait till the last minute to make the payment then although you are doing tax planning, it is not efficient way, as you are losing the interest you would have earned had you planned the investment in SIP mode. This will also avoid the situation of not cash in one month due to last minute investment to save tax.
Also, if you are planning to accumulate wealth for your retirement, then you should plan for portfolio of various financial instruments like Mutual funds, Insurance endowment plans, monthly income plans, real estate for rental income etc. Mostly a combination of Monthly Income and Annuity plans will give better tax efficiency compared to dependence on only single annuity income because most of the monthly income plan, if coming as maturity of the insurance plan are tax free compared to annuity plans which are taxable in the hands of the receiver.
Conclusion
Prioritizing tax planning over goal setting or vice versa should not be done because these are complementary in nature as tax planning without goal setting is inefficient and goal setting without tax planning will not help you in accumulating large corpus of funds due to drain of funds in taxes. Therefore, goal setting and tax planning should go hand in hand in the process of investing