A penny saved is a penny earned. Tax planning will help do exactly that and more. A smart way to plan for tax is to use all applicable sections and provisions of the Income-Tax Act. That way, you can optimise the tax outflow as well as get an opportunity to create wealth.

Tax planning is hence an integral part of financial planning. Tax planning options can be structured to help realise financial goals and thereby help generate and preserve wealth too.

Tax planning can be classified into:

(a) investments that generate income that is exempt from tax

(b) payments or investments that reduce the total taxable income.

Exempted Income

Exempted income is does not form part of the income chargeable to tax. Two examples of this are investments that provide

(a) Dividend income from shares that are exempt from tax u/s 10(34) and

(b) Income received in respect of units of a mutual fund u/s 10(35). The recently issued NHAI or HUDCO tax free bonds, where interest is not subject to tax is an example from the debt side. The focus of investing in instruments that generate exempted income is that it provides periodic cash flow. This can be used either for paying recurring expenses or for reinvesting to increase the capital value.

Tax saving

Payments or investments that reduce the total taxable income can be classified under the three sections of the Income-Tax act namely

(a) Section 80C – Contribution to the Provident Fund (PF), National Savings Certificate (NSC), Investment in Equity Linked Savings Scheme (ELSS) of a Mutual fund , payment of Life Insurance premiums, repayment of home loans and tuition fees for children.

(b) Section 80CCF – Investment in Infrastructure Bonds

(c) Section 80D - premiums paid towards a health insurance plan on the health of self, spouse, dependant parents and dependant children.

These tax-saving investment options provide for long-term wealth generation as well as wealth protection from contingencies. In addition, the opportunity to invest in different assets such as debt, equity, real estate provides for a well-planned asset allocation strategy that forms an integral part of a financial plan.

Adiversified portfolio can be constructed by investing in ELSS or Unit Linked Insurance Plans (ULIP) that provide for indirect exposure to equity and in fixed income generating investments like PF, NSC and Infrastructure Bonds that provide reasonable stability for the principal money invested.

While these investments provide for wealth generation, certain plans like Life Insurance and Health plans provide for wealth preservation. Insurance forms an important part of risk management by offering protection from financial adversity caused by unexpected events.

Selecting investments

Many people end up investing for tax at the last minute with the sole objective of tax saving and end up investing in wrong products. It is important to assess the amount of time for which the investment will be made and to accordingly start investing early.

Investing early also provides opportunity to assess investment risk of various instruments and choose appropriately.

It is important to allocate the tax planning investment options across equity, fixed income and protection products; this will help in both generation and preservation of wealth.

Selection of the right investment product should be based on the risk tolerance and asset allocation needs of the investor.

A well thought-out tax plan that forms part of the financial plan can be used to leverage wealth and grow that wealth.

(The writer is Vice-President, Product Advisory Group, ICICI Securities.)

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