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Most individuals we come across, are more worried about saving taxes than saving for their future.
However, in the pursuit to save taxes, individuals more often than not, ignore financial planning. Many are of the opinion that planning their personal finances can be accorded a lower priority, after tax planning. They believe that financial planning is relatively simpler and thus, can be done on their own while tax planning isn't that easy.
If you look up for the definition of tax planning, Investopedia says it includes planning of income, expenditure, tax filings and common deductions. It adds that while tax planning is an important element in any financial plan, it is important to not let the 'tax' tail wag the financial 'dog', as the same may turn out to be counter-productive. Tax planning and financial planning share a lot in common. Here's how the two compare.
Saving taxes
Every taxpayer wants to pay the least amount as taxes and one of the first motives of tax planning is to achieve this. In contrast, the motive of financial planning is to help individuals save money.
Over the last few years, saving money has become difficult with the increasing optimism about spending among the youngsters and middle aged population. Soaring inflation has resulted in prices of essentials going up and higher standard of living, which implies higher monthly budgets for living and leisure expenses. Education costs have seen no recession over the last five years. More number of individuals are taking loans and so that many working families are servicing the same, having left with no room to save.
In such circumstances, financial planning helps individuals to plan and start saving money little by little, by using various strategies like expenditure management, debt management, accelerated savings plans, and so on. There is no point in only saving taxes if it doesn't help in increasing savings.
Reducing taxes
If paying taxes is inevitable, tax planning often helps individuals with ways to reduce the liability. Similarly, financial planning is a great tool to reduce the uncertainty around an individual's monetary capability for achieving their aspirations in future.
Typically, financial goals include a new car, a house or a bigger one, foreign holiday, higher career planning, children's education, financial independence after retirement, parents and so on. A comprehensive financial planning helps enhance an individual's quality of life and increase satisfaction by reducing uncertainty about the availability of resources for their future needs. It helps in instilling a sense of freedom from financial worries obtained by anticipating the future fund inflow, expenses and providing for the same. Simply put, planning your finances help take charge of and deal better with future economic uncertainties.
Making investments to save taxes
Planning ones investments to save taxes is something that every taxpayer undertakes at the beginning of each financial year and also during the last 3 months of the year. However, financial planning aims to make investments to help achieve various financial objectives around the year.
Discipline is the key, when it comes to investing for ones objectives, that is, future. Even without financial planning, many invest their money into instruments like fixed deposits, mutual funds, shares, property, but allocating these investments as per future objectives is of prime importance. An individual may have a higher savings ratio but in the absence of a clearly chalked out map, investments have no meaning in the long run.
Allocating investments in accordance to goals would include factoring the time horizon available and the risk appetite of each objective.
This would help in advising the right kind of investments. Say a 28 years old is looking to accumulate money for down payment of his new house in the next 2 years, he should not touch equities, although his risk appetite should be high in this age.
Reducing income tax liability
One of the 3 pillars of tax-planning is the income-based approach, wherein strategies are used to plan the receivable income in ways to reduce the tax incidence. A financial planner seeks to help an individual increase his disposable income, which need not always mean higher returns on your savings. It also implies how judiciously income earned is spent / invested. Not deploying premiums for a policy, which is unsuitable for an individual, on a planner's advice should be looked at as a measure of higher disposable income available.
Many times very high income earners are seen struggling for money at the end of a month. Such situations need something beyond traditional tax-planning.
To summarize, financial planning is more holistic than tax planning and both are equally challenging. If understanding tax laws is difficult, dealing with uncertainties in your financial life is definitely not easy. Thus, if tax planning helps reduce 30 per cent tax burden, financial planning is how best you carry the rest 70 per cent on your shoulders.
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