Many people invest just for tax planning. They have either not planned their financial goals, or haven’t aligned tax planning with their financial goals. Ideally, an individual should take the comprehensive financial planning approach that involves listing down all the goals, making a financial plan for each of them, and accordingly investing in financial products that give the maximum tax benefits.
In this manner, an individual can have comprehensive financial planning at a broad level, goal planning at the second level, and aligning tax planning with goal planning at the third level. Let us understand how you can do this step-by-step.
The comprehensive financial planning approach involves taking the following steps:
Building and maintaining an emergency fund
Every salaried individual should build and maintain an emergency fund with 3-6 months of expenses. If you are working in an organisation/industry that is not doing well financially and is prone to financial turbulence resulting in lay-off/job cuts, you may increase the emergency fund to 6-9 months of expenses. If you are self-employed with lumpy earnings, you may maintain an emergency fund with 6-12 months of expenses. The emergency fund is useful for unexpected events such as job loss, delay in salary, salary cut, hospitalisation, etc.
You may choose to keep the emergency fund money in a savings account or a liquid mutual fund. The interest earned on a savings account is eligible for deduction from taxable income under Section 80TTA of the Income Tax Act. The maximum deduction allowed in a financial year is the interest amount earned or Rs. 10,000, whichever is lower. Senior citizens can get a higher deduction of up to Rs. 50,000 in a financial year on interest income under Section 80 TTB.
You can also choose to maintain your emergency fund money in a liquid mutual fund. While there is no tax benefit at the time of investing, the tax treatment at the time of redemption is better. If the units are held for more than 3 years, the capital gain is categorised as long-term capital gain (LTCG). The LTCG tax is levied at 20% with the indexation benefit.
Buying term life insurance for family bread earners
Along with your emergency fund, you can start planning for your life insurance in parallel. All family bread earners should have life insurance. You may consider going for a term life insurance plan first. The cover should be adequate to pay for your loans and financial goals in your absence.
The premium paid for a life insurance policy is eligible for deduction from taxable income under Section 80C of the Income Tax Act. The maximum deduction allowed in a financial year is the premium amount paid or Rs. 1,50,000, whichever is lower. Also, the death benefit received from a term life insurance policy is tax-free in the hands of the nominee/legal heir. In this manner, you can buy life insurance based on your needs and avail of tax benefits on it.
Buying health insurance for all family members
Once you have bought a life insurance policy for yourself, you should buy health insurance for the entire family. The Covid pandemic was a wake-up call for all of us on how important health insurance is. You may buy a family floater health insurance policy for the entire family. You can pay the premium for yourself, spouse, and dependent children.
The premium paid for a health insurance policy is eligible for deduction from taxable income under Section 80D of the Income Tax Act. The maximum deduction allowed in a financial year is the premium paid or Rs. 25,000, whichever is lower. If you or your spouse or both are senior citizens, then the maximum deduction allowed is Rs. 50,000.
You can avail of a separate deduction for health insurance premium paid for your parents. The maximum deduction allowed in a financial year is the premium paid or Rs. 25,000, whichever is lower. If one or both parents are senior citizens, then the maximum deduction allowed is Rs. 50,000. In this manner, you can buy need-based health insurance for your entire family and avail of tax benefits on it.
Financial goal planning
You can make a financial plan for each of your financial goals such as building a fund for your child’s higher education or your own retirement. When investing for each financial goal, you should follow appropriate asset allocation by diversifying your investments into domestic equity, international equity, debt, gold, etc.
You may consider investing some portion of the equity component in an Equity-linked Savings Scheme (ELSS). The ELSS investment is eligible for deduction from taxable income under Section 80C of the Income Tax Act. The maximum deduction allowed in a financial year is the amount invested or Rs. 1,50,000, whichever is lower.
You can get some tax benefits at the time of redemption also. When the ELSS units are sold after a year, the profit is treated as long-term capital gain (LTCG). The first Rs. 1 lakh LTCG in a financial year is exempt from taxation. The incremental LTCG is taxed at 10% without indexation benefit.
There are many options to invest in the debt portion of the portfolio. Some of these products with tax benefits include the Public Provident Fund (PPF), National Savings Certificate (NSC), tax-saving fixed deposit, etc. Investments in these products are eligible for deduction from taxable income under Section 80C of the Income Tax Act. The maximum deduction allowed is the amount invested or Rs. 1,50,000, whichever is less. With PPF, the returns on maturity are also tax-free.
For the gold portion of the investment portfolio, you can invest in various ways such as gold bullion, gold exchange-traded funds (ETFs), gold mutual funds, digital gold, or Sovereign Gold Bonds (SGBs). The SGBs have the benefit of paying an interest of 2.5% p.a. Also, if the SGBs are held till maturity, the LTCG is exempt from taxation.
In this manner, you can take the comprehensive financial planning approach. With every step, such as an emergency fund, life insurance, health insurance, financial goals, etc., you can do a need-based analysis. Accordingly, you can choose from the various financial products available and evaluate the tax benefits, and finally decide to invest.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn