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Tax planning mistakes to avoid Research Team | Posted On Wednesday, February 18,2015, 04:18 PM

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Tax planning mistakes to avoid




Thinking of tax reminds you of the famous words "The hardest thing in the world to understand is the income tax." Yes… tax can be very difficult but only if you do not do your tax planning.Remember Tax planning is serious business and you cannot afford to make mistakes while doing it.

You buy too many life insurance policies

You get tax deductions under Section 80 C of the income tax act up to INR 1.5 Lakhs on the premiums you pay if you avail a life insurance policy. But should you buy 3-5 life insurance policies just to avail tax benefits? You must always buy only a life insurance policy which suits your needs. If you are young, newly married and just starting your career, you need to pick up a term life plan.

The premiums are low for a high sum assured for a fixed time period if you are young and healthy. You could also avail rider benefits (Additional benefits you get on paying a slightly higher premium). A critical illness rider pays a lump sum in case of a critical illness such as a heart attack or cancer.

If you survive the term of the policy you do not get any benefits. If you pick up a number of endowment life policies just to save on tax you would have to pay a high premium for a much lesser sum assured. Most of the premiums you pay for the endowment life plan would be paid as commission to the life insurance agents.

You must avail a term life plan with a cover (sum assured) of 12-15 times your annual income if you are young, just married and are early in your career.

Look beyond Section 80 C to save on tax

Besides the deduction of INR 1.5 Lakhs you get under Section 80 C of the income tax act on select financial instruments you get a further deduction of INR 15,000 a year on the premiums you pay for a health plan for you and your family. (Family floater health plan).

You can also avail a health plan for your parents who are senior citizens (60 Years and above) and avail a deduction of INR 20,000 a year on the premiums you pay for the health plan.

Plan your taxes

Is tax planning a last minute job for you? Are your budget and finances a mess because of this last minute tax planning?

Start your investments in tax saving instruments as early as possible and in a staggered manner (Small sums of money invested in tax saving instruments throughout the year) instead of a single one time investment at the last minute.

You can invest small sums of money in an SIP of an ELSS if you are an aggressive investor. You will get higher returns from an ELSS but at a higher risk. If you are a conservative investor you can invest small sums of money in a PPF which allows up to 12 transactions a year.

If you invest small sums of money in tax saving financial instruments throughout the year it will be a less burden and you will be able to budget your finances in a better manner.

Keep an eye on your portfolio

If you are young and an aggressive investor you will have a large part of your portfolio in equity (shares and mutual funds). If stock markets crash your investments will fall in value and you will be in heavy losses.

You must invest in tax saving financial instruments which are conservative in nature such as PPF, NSC or a 5 year tax saver FD as part of your tax planning. This will help achieve a balance between debt-equity in your portfolio.

If you are a conservative investor and invest in safe products such as a fixed deposits then you must consider a more aggressive approach in your tax planning especially in your early years. You need aggression (equity) in your portfolio which will give you high returns (you need it at this stage in life) but at a higher risk.

You could invest in ELSS where you can avail a tax deduction up to INR 1.5 Lakhs on the money you invest under Section 80 C. The returns you get from conservative investments are on the lower side even though your investment is safe. A dose of equity can give you a higher return you so badly need.

Note the lock in period of your tax saving investments

You need to note the lock in period of your tax saving investments before you invest your money in them. Conservative financial instruments such as PPF have a lock in of 15 years. Tax saver FD and NSC have a lock in of 5 years.

Even aggressive tax saving alternatives such as ELSS have a lock in of 3 years.

Your money is locked (You cannot touch it) for that time period (5 or 15 years) and you need to make a decision if lesser returns from (PPF and NSC) where your money is safe, is better than an ELSS with a lock in of 3 years where you get higher returns at a higher risk.

Check the yield of your tax saving instruments

Before investing in a tax saving instrument understand the meaning of the word "EEE" where the money invested in a tax saving financial instrument up to a particular limit (Investments up to INR 1.5 Lakhs are tax deductible under Section 80 C), The money accumulated with time, and the maturity amount withdrawn at the time of maturity are free of tax.

Investments in a PPF or an ELSS enjoy "EEE" status, whereas you are taxed on the returns from an NSC or a tax saver fixed deposit.

Tax planning is not a simple job to do at the last minute. "The early bird catches the worm". Start your tax planning early and enjoy its benefits.

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