Thursday, January 28, 2016

Tax Saving for 2016 Part 2

 Tax Saving Online
 
Tax Planning Strategies article in Advisorkhoj - Tax Planning at different stages of life: Part 2
 

In the previous article of this series, Tax Planning at different stages of life – Part 1, we have discussed some tax planning ideas for people in the age group of 20 – 30 years and 30 – 40 years. Tax planning is an integral part of our financial planning process. While there are various aspects of tax planning, our focus in this series is on tax saving. Tax saving investments under Section 80C should be aligned with our financial planning objectives. In other words, investors should ensure that tax-saving investments are in sync with our financial goals, financial situation, risk profile and the optimum asset allocation guidance. Our financial situation and goals are not static and change over time. Accordingly, tax planning should not be a mechanical exercise to meet the Section 80C requirement, but should be tuned according to the needs of the different stages of life. In this article, we will discuss tax planning ideas for people in the age groups of 40 – 50 years, 50 – 60 years and beyond 60 years. The tax planning strategies discussed in this article are general guidelines. Your tax planning strategies will depend on your own financial situation and specific financial goals.

Tax planning in the age group of 40 – 50

By the time you reach your forties, you are well settled in your respective careers. Your income is much higher than in the previous stages of life. Your children are also growing up and their education is an important goal at this stage. Retirement planning is also a very important financial planning objective in this stage of life. The risk tolerance of the investor in the forties is moderate to high. Non investment related tax savings should comprise a major portion of the 80C deductions of the tax payers in the age group of 40 - 50. Here are some tax-planning ideas for this age-group.

  • If you have a home loan, you should try to prepay part of your home loan principal on a periodic basis. By prepaying your home loan principal you will reduce the interest burden on your home loan (please read our article, Should you Pre Pay your Home Loan). Home loan principal payment qualifies for deduction under Section 80C of the Income Tax up to a limit of Rs 1.5 lacs as per the new Budget. One should note that for calculation of principal payment, both principal payment under Equated Monthly Instalments (EMIs) and principal prepayment should be considered. Prepaying principal is always a good idea since it reduces your interest cost. Interest rate on home loan is almost always higher than interest earned on fixed income investments. Also by prepaying the principal, you will be debt free in a shorter period of time. Hence, principal prepayment should be a priority.

  • You should also claim deduction for interest paid on home loan for a self occupied property under Section 24 of the Income Tax Act up to a limit of Rs 2 lacs as per the new Union Budget

  • With increase in salary the 80C deduction on account of contribution to the employee provident fund is also substantially higher.

  • If you have children, you can claim 80C deduction towards their school tuition fees.

  • As discussed in our previous article, Tax Planning at different stages of life – Part 1, your life insurance premiums will also qualify for 80C deductions. At every stage of life you re-evaluate your life insurance cover and make sure they are adequate for your needs.

  • With your contribution to EPF, home loan principal payment, children's tuition fees, insurance premium and home loan principal payment, you should be able to meet the 80C tax saving limit and therefore you may not have to make any tax saving investment. In case you have to make tax saving investment under section 80C, you should make retirement planning your investment objective. Tax saving mutual funds (ELSS), National Pension Scheme (NPS) and Public Provident Fund (PPF) are preferred investment choices. You should ensure optimum asset allocation in your tax saving investments.

Tax planning in the age group of 50 – 60

Your income is now at the highest level of your entire career. Debt repayment and retirement planning are two most important financial goals in this stage of life. The risk tolerance of the investor in this stage of life is moderate to low. Here are some tax-planning ideas for the 50 – 60 age group:-

  • If you have a home loan principal outstanding, you should try to prepay it part or full. You can claim 80C deduction for home loan principal payment.

  • If you are paying home loan EMIs, you will get deduction for the interest paid under Section 24.

  • Since your salary is now at the highest level of your entire career, your EPF contribution will be a substantial part of your 80C tax saving

  • You should continue to claim 80C deduction towards your children's school tuition fees.

  • With home loan principal payment, EPF, children's tuition fees and your life insurance premiums, you may not have to make any tax saving investments under 80C. But if you have to make tax saving investments under 80C, make retirement planning the only investment objective. Tax saving mutual funds (ELSS), National Pension Scheme (NPS) and Public Provident Fund (PPF) are again preferred investment choices. Since your risk tolerance is moderate to low in this stage of life, you should make sure your asset allocation is aligned with your risk tolerance.

  • Children's higher education is an important goal for many parents. As such you should start saving and investing for your child's future on a long term basis from a young age (please read our article, Investing for the future of your children). If unfortunately, you have not been able to save and accumulate enough for your child's higher education by your fifties, you should not prioritize funding your child's expensive higher education over your retirement planning. You should avail of educational loans for your child's higher education. Once your children complete their higher education and start their careers, they can pay off the educational loan. You can claim deduction on the interest paid on your child's education loan under Section 80E of the Income Tax Act. There is no upper limit and the entire amount of interest paid in the year is eligible for deduction.

  • If you still do not have health insurance cover, apart from the group health insurance plan of your employer, now is the time to get your own Mediclaim. Getting Mediclaim after your retirement is difficult. As discussed in our previous article, Mediclaim premiums are eligible for deduction from taxable under Section 80D of the Income Tax Act

Tax planning above 60

After retirement capital protection, income and health insurance are important financial objectives. Though capital protection is an objective after retirement, with increasing life spans and high inflation, equities, appropriately weighted in your asset allocation, should continue to form a part of your investment portfolio. Having said that, at this stage of life, your investment should pre-dominantly be in debt

  • You should consider investing in Senior Citizens Savings Scheme (SCSS). The minimum investment limit in this scheme is Rs 1,000 and the maximum limit is Rs. 15 lacs. This investment qualifies for deduction under section 80C of the IT Act. From a liquidity perspective, the scheme has a period of 5 years and carries an interest rate of 9 per cent, one the highest applicable rates for similar instruments. A penalty of 1.5% per cent is levied on the amount deposited, in case the deposit is withdrawn before 2 years and 1% if the amount is withdrawn after 2 years, but before the expiry of the term. If the returns from this instrument do not exceed the basic exemption limit of Rs 2.4 lacs, they stand to earn tax-free returns. Seniors who have their immediate liquidity concerns addressed though other instruments, should try to maximise investments under this scheme using their surplus funds, since this offers attractive returns and capital safety

  • Health is an important aspect of our life at any age, but is extremely important at this stage. It is important that you have a long term health insurance plan to address you and your spouse's healthcare needs, even in your retirement years. Senior citizens, who were covered under their employer's group health insurance plan before retirement and did not have an additional individual health insurance or Mediclaim plan, have two options, upon retirement.
  • Immediately on retirement, seniors can switch to the retail policy of the insurer offering the group insurance plan to their former employer. IRDA's portability guidelines cover policy transfers from group to retail, allowing retiring employees to exercise this option. However, the premiums and the policy terms may change once you switch to the retail plan. In this option certain benefits like waiting period of pre-existing medical conditions, will be carried over from the group plan to the individual plan. However, in this option, you have to continue with the group plan insurer.

  • The senior can consider buying an individual health cover from an insurer of his or her choice. Essentially this means that you are buying a new policy, with new terms and conditions.

Seniors should evaluate both the options and then make an informed decision depending on their personal situation. As discussed earlier, you claim tax benefits under Section 80D for your Mediclaim premiums.

Conclusion

Tax Planning is an important financial planning objective. With prudent tax planning, you can not only save taxes but make appropriate investment decisions that will help you meet your long term investment objectives. However, we should be careful in interpreting the various provisions under the different sections of the Income Tax Act and in case of any confusion consult a chartered accountant or tax consultant.

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