Know the right approach to tax planning

It is that time of the year again where tax saving becomes a high priority task in your 'to do' list. The approach followed by most is the last minute scampering to find out how much you need to invest in order to avail the maximum benefit under Section 80C.

Almost effortlessly, three investment options come to mind: Equity-linked savings scheme (ELSS), unit-linked insurance plan (ULIP), and Public Provident Fund (PPF).

You choose to put your money into one or more, satisfied that you were able to invest well in time and blissfully erase tax saving from your memory until next year. While this approach makes you save tax every year it has its pitfalls and the earlier one recognizes the importance of the right approach to tax saving, the better it is.

Kunnath Santhosh, Co-founder and Director, Perfios software Solutions Pvt. Ltd.  Perfios (www.perfios.com) offers an online Personal Finance Software Solution that provides a 360 degree view of one's Personal Finance with very little manual effort.

Tax saving, if not planned properly can lead to incorrect investment decisions. While no investment is good or bad in itself, it is the suitability of the product to an individual which decides whether an investment is good or bad for her/him.

Hence, investment in ELSS by a risk-averse investor and investment in PPF by an investor with a high-risk appetite can be bad investment decisions.

Tax saving can be planned in such a way that it aligns with your goals, risk appetite and return expectation. The best part is that it does not take mammoth effort to achieve this.

For those who have not identified their future financial goals, the first step would be to do so. Retirement planning, children education, marriage, buying a house etc are important goals for most households.

The next step is to know the different investments which qualify for tax saving under Section 80C.

Investments in PPF, NSC, ELSS, tax saving fixed deposits, infrastructure bonds, pension funds, senior citizen savings scheme, post office time deposits, premiums paid for any life insurance policy, contribution to provident fund, home loan principal repayment and children education expenses qualify for deduction under Section 80C. The maximum amount of deduction is Rs 1 lakh.

Aligning an investment to a goal is of utmost importance. Even better if the investment were to bring about tax saving.

For example, instead of buying any ULIP plan in order to save tax, it would be better to align it to a future requirement and then select a suitable insurance policy. A unit linked child plan could help an individual in planning for her/his child's education and also take care of the tax saving aspect.

Similarly, retirement planning could be aided by investments in PPF. You may be better off paying a part of your home loan principal and reducing your interest burden and at the same time being eligible for a tax deduction.

If safety of money is important, then PPF, NSC and fixed deposits are the right instruments. If one has to plan for certain other goals, ELSS would be the right investment.

Once you have invested in the right tax savings instruments and continue to do so year after year, your entire portfolio of tax saving instruments would align to your long-term goals.

Evaluate your investments every year to check if you are on the right track. It also makes immense sense to not keep your tax related investments pending till the year-end. Investing regularly and spreading the investments over the year helps improve the cash flow.

For equity related investments, it reduces the risk associated with one time investment and helps to average out the costs.

Hence, approach tax planning differently, more as a part of overall financial planning than as a one-time exercise to be done every year-end. Acting on a well chalked out plan will ensure that you are on the right path to achieve your goals and you are also saving tax along the way.