Can you Save Taxes with Smart Financial Planning?

If retiring early OR having enough money to live a life that you truly want is your aim, then let me tell you one thing.

Tax Saving alone will not help you much.

I agree that no one wants to pay taxes if given a choice. So, people try to avoid it to the extent that it’s legally possible with better and ultra-smart tax planning. But unfortunately, some people become so focused on saving taxes that they fail to see the forest in search of trees!

I know that for most people, trying to minimize tax obligations is like an annual pilgrimage. 😉

Investing to save taxes by itself serves a limited purpose. It’s best to align the idea of tax-saving with the overarching plan for your financial goals and then get the maximum benefit from the available tax-saving products. My general advice before proceeding would be to not focus too much on the best strategies for tax-saving products.

Tax saving should be a result of proper investment planning and not vice versa.

Making Tax Saving part of a Bigger Plan

Planning for financial goals and that for tax savings should not be a stand-alone exercise.

Those who focus on tax saving more fail to realize that at times, most popular tax-saving products may not be the right ones for the actual financial goals. A big example of this is mixing insurance with investments.

A goal-based financial plan gives investing a perspective and helps track one’s progress towards those goals. Such a plan will consider the income and savings capabilities of the individual, their financial goals and their risk profile. And then arrive at a tax-efficient plan to help achieve those goals.

Let me try and simplify it for you.

• First, you need to be aware of your income. I know most people know all that stuff. But some still have confusion about how they end up getting the so-called ‘in-hand’ salary that is much lesser than what the company tells them as their annual CTC. 😉
• Estimate your total taxable income for the year (including salary, rent, etc.). Don’t forget to deduct the exempted income (like HRA, LTA, etc.) from the total income while calculating taxable income.
• Find out your tax liability for the year. Different people have different tax liabilities depending on which tax slab they belong to. You can take help of a CA or use income tax calculators that are easily available online. Do this even before you begin your search for best tax saving products or your actual investments.
• Next factor in your expenses. Estimate how much your basic expenses that you really cannot do without are. Once that is done, you will know what scope you have for saving taxes by way of investing in different products under various sections of the income tax act.
• Now you know few important things: Your tax liability and your ability to save (after basic expenses are taken care of).
• Some tax saving can happen automatically via certain expenses. Like insurance premiums, home loan obligations, school fees, etc. Your mandatory contribution to EPF is also eligible for tax saving. So all these expenses and mandatory savings reduce the need to look for tax-saving products (partially or fully).

With the basics out of the way, now comes the important part.

• Find out your real financial goals first (here is some help – detailed How-To Guide & Free Excel Download).
• Once you are clear about your goals, you need to identify which investments options to choose to assign to each goal so that you can save taxes too.

Sidenote: Do note that I am focusing more on financial goal achievement and not just on tax saving. And that is the way to go. Do you wish to retire quickly or you wish to maximize your tax-saving by randomly investing in wrong financial products?

• With goals identified and rationalized, use goal-based investing to choose correct investment products that can help you reach your financial goals. Tax efficiency is a secondary. Remember that. At best, it should be linked to the process of identifying suitable investment products.
• There are several products that also offer tax benefits – like PPF (Free PPF Excel Calculator), ELSS funds, NPS, traditional insurance plans, NSC, some FDs, home loan repayment, EPF, VPF and whatnots… Evaluate the features of these products – risk vs return, tenors and lock-ins, flexibility in making investments and receiving amounts on maturity, etc. Also important is understanding the tax treatment – whether it’s EEE, EET or something else. Here again, you can use some tax guide or take help of an advisor to understand the nuances of these products.
• Please remember that the actual product should be chosen in alignment with your unique circumstances in terms of ability to take risks, need for liquidity and investment horizon. One size doesn’t fit all. You cannot copy-paste someone else’s financial plan in your own life. That would be a huge mistake to commit.
• And as far as possible, your tax-oriented investments that are already part of your existing portfolio should also be aligned with your financial goals.

Also, due weightage should be given to whether the choice of product should be in alignment with your overall portfolio’s required asset allocation.

As an example, if you are young and have the ability to save about Rs 1.5 lac, then it makes no sense to utilize it fully via EPF+PPF combination. Being young you should have a significant investment in equity – which here can be utilized via ELSS funds. Read more about how young earners should plan their investments.

Remember…

The purpose of investing is to achieve your financial goals and not just tax-reduction.

Read that again please.

A well thought out investment strategy is the core idea of a good financial plan. Some people know how to figure out a good tax-efficient strategy on their own. But for others, it’s best to seek proper advice from investment advisors (and avoid free investment advice).

A well thought out financial plan can help investors achieve their financial goals in a smart and tax-efficient manner. You can read more about smart financial planning to clear your thoughts.

Finally…

Talking about your tax-saving battles and victories can be glamorous. 🙂

But if that victory, i.e. maximization of tax saving comes at the cost of choosing wrong financial products, then you will lose out in the long term. And by the time you will realize about your mistake, it will be very (if not too) late.

Do yourself a favor and put in place a proper investment plan for yourself – so that your tax saving investments can contribute more to the overall portfolio and help you achieve your financial goals.

Last minute tax saving efforts will almost always lead to unwise decisions. So avoid waiting to bunch your investment decisions to the end of financial year (Jan-Mar).

However, if you are already late and you realize that… then make sure you don’t repeat this mistake again next year.

Find yourself a good financial advisor and talk to him. Engage him to put in place a good financial plan that you can implement when the next year (or financial year) begins. Give yourself a head start. Or if not now, put a calendar reminder to get in touch with an investment advisor as soon as possible.

Good tax saving investments are no doubt an opportunity for you to start your wealth creation journey. But remember that personal financial goal planning should precede your tax planning. Keep your financial needs in mind and then link your tax saving plans with your financial goal related investments.