Money
Tax & investment tips for young earners
Summary
Tax planning should be part of overall financial planning and not the other way round
Ramesh Verma, 28, has his tax planning game on point. He has fully utilized the ₹1.5 lakh 80C limit, makes ₹50,000 contribution to National Pension Scheme (NPS) for deduction under Section 80CCD(1B) and is repaying an education loan. But ask him about his financial goals or an emergency fund and Verma falls short of words. “I have little liquid savings but with my current tax-saving plan my taxable income is below ₹5 lakh exemption limit and I don’t have to pay any tax," he said.
A 10% appraisal will easily push Verma’s taxable income outside the ₹5 lakh exemption refuge.
Of course, he will still pay lower tax but Verma’s tunnel vision to save tax has put his financial goals on a back burner.
Experts advise that tax planning should be part of overall financial planning and not the other way round. For instance, NPS is becoming a popular tax-saving choice given lack of options beyond the limited 80C limit.
However, a product with a lock-in till retirement may not be a suitable investment avenue for young investors if they don’t have their more immediate needs sorted.
“For those in their 20’s, generally speaking, it doesn’t make sense to invest in NPS with long lock-in as they will require funds for meeting their short-term financial goals and obligations like higher education, wedding, vehicles, holidays etc," said Raj Khosla, founder and MD, MyMoneyMantra.com.
This is not to say that NPS is a bad investment when done early, but early in your career, liquidity is key.
“If investments towards any of the other goals do not suffer or your overall finances don’t squeeze due to the annual ₹50,000 allocation in NPS for tax-saving, one should definitely go ahead with it. It’s never too early to start saving for retirement," said Prableen Bajpai, founder, FinFix Research.
Kartik Sankaran, founder, Fiscal Fitness, said if an investor is looking at a horizon of about 30 years, he/she should instead look at good quality small and mid-cap funds.
“They carry higher risk but can also deliver much higher returns and can be safely used in portfolios that span over 10-20 years. Even if one were to pay additional capital gains at the end of 20 years, they would still be left with more money in hand than seeking tax-saving opportunities that compound money at lower rates," he explained.
Maximise tax saving
The first place to look at is Section 80C through which you can save ₹1.5 lakh in taxes. Among the options under 80C, Equity Linked Savings Scheme (ELSS) is the best bet as it comes with the shortest lock-in of 3 years, can yield highest returns among all options and has a simple structure to understand, as opposed to ULIPs. For the risk-averse, provident fund with sovereign guarantee is a good option.
Avoid traditional life insurance plans at all costs.
“Tax breaks on life insurance products prove to be more expensive than paying the tax. Maturity proceeds are tax-free under certain conditions and you get a tax break today but then live with over 20 years of poor returns," said Sankaran.
If you do have to buy life insurance to protect dependent parents or siblings or cover a loan, buy a term plan which also falls under 80C.
Health insurance is another option. It is recommended to buy standalone health insurance at the earliest to protect against health emergencies and the tax benefit you will get is a bonus. You can claim up to ₹25,000 of the medical insurance premium paid towards a policy for you or your parents under section 80D. For senior citizen parents, the deduction limit increases to ₹50,000.
However, don’t buy an expensive policy right away just to total up the premium amount to ₹25,000.
“The cover you need should also align to the budget that one has for medical insurance premium payment. You can take two insurance policies – an individual medical insurance for ₹5 lakh and a super top-up plan of ₹20 lakh with ₹5 lakh deductible and the premium will range from ₹8,000 to ₹11,500," explained Lovaii Navlakhi, chairman, Association of Registered Investment Advisors (ARIA).
Opt for new regime
As we are nearing the deadline to make tax-saving investments, instead of rushing into an unsuitable investment just to meet this year’s requirement, an effective way to reduce your tax outgo is to opt for the new tax regime with lower tax rates, said Bajpai.
Under the new regime, incomes between ₹5 lakh and ₹7.5 lakh pay 10% tax and between ₹7.5 lakh and ₹10 lakh pay 15% tax.
In contrast, the old regime tax requires incomes between ₹5 lakh and ₹10 lakh to pay 20% tax. In higher tax brackets of ₹10 lakh to ₹15 lakh, you pay 30% tax under the old regime, whereas 30% tax in the new regime kicks in for incomes above ₹15 lakh.
“A few years into working, people don’t always have clarity about their future goals or they may plan to leave their job for higher education or to start a venture. In such a case, instead of locking your money in unfavourable investments, opt for the new regime and pay lower taxes," Bajpai said.
This is especially helpful for salaried individuals as they have the option to switch back to the old regime anytime they want depending on their prevailing financial situation. Those with business income get the option to switch back to the old regime after opting for the new regime only once in their life. Salaried individuals should take note that derivatives trading and freelance income also counts as business income.
