Bring Hierarchy of Needs while using tax savings!

It is an unfortunate for those people who tend to have primary goal to save taxes without knowing their financial needs about what it means to them other than the money they save in doing so. For the past 5 years, Noida-based Mr. Amit Shah aged 35 years has been paying taxes and using Maslow’s Hierarchy of Needs, which is one of the most famous theories with regards to human psychology. He is doing so in a planned manner, dovetails it to his finances, especially tax planning. If you think Mr. Shah is an exceptional case, you will be amazed at how like you more and more people are moving towards planning their taxes early in the year. As our tax structures getting simpler, are leaving more room to make the annual tax-planning exercise could just make your future financially sound, secure and a lot wealthier. The window to save tax is the same whether you earn Rs 5 lakh a year or Rs 5 lakh a month. Thankfully, all tax payers can, now save taxes up to Rs 1.50 lakh under section 80C from this financial year 2014-15 which is a 50 percent increase in the deduction limit compared to last year, when it was Rs 1 lakh. Like the most other things in personal finance, the answer to the best tax plan will vary from one’s financial needs of person to person. While using the hierarchy model, especially tax planning, it could turn into a potent tool.

Health Insurance

Most people often, buy health insurance plan when they have exhausted all saving limit of Rs 1.50 lakh under section 80C. As hierarchy of our first financial needs is to protect our current financial resources which could be shell out in the day of high health care and medical costs. Fundamentally, every tax payer must look beyond the tax benefits. Focus on tax benefits makes the tax payer miss the wood for the trees. At the base of one’s tax plan, every tax payer should prima facie buy health insurance irrespective of the tax benefits that comes with the policy. You should understand that benefits under Section 80D are an added bonus and not the core benefit of securing oneself with an insurance policy. Like other tax savings alternatives, health insurance is a boon for those people who do not just take health insurance to meet their needs, but also to reduce their tax income tax liability.

Though, several employers do provide health insurance as part of compensation, you should take a separate health insurance for yourself and claim deductions of up to Rs25,000 under section 80D, which also includes payment on account of preventive health check-ups, subject to a cap of Rs5,000. You can get an additional Rs5,000 deduction while taking this policy for elderly dependents, as senior citizens qualify for another additional Rs5,000 deduction under this section. It must be noted that health insurance should not primarily be bought from the point of view just saving on tax, but because one requires it. (Also Read: Is your Company Group Health Insurance Cover adequate?)

Life Insurance

The next step should be to protect your life with adequate term insurance to ensure your financial dependents are taken care of financially in the event of demise. Though life insurance plays a significant role in maintaining and protecting the lifestyle on one’s family, it is sold in the name of investment, not just as insurance. There is a fault in the distribution architecture if the product cannot be sold for what it is. Life insurance is one of the most critical effective tax planning instruments where current generation is living on credit, be it in the form of home loans, credit card, personal loans or car loans. It becomes rather more important that one has life insurance so that they can at least repay loans and protect next 15 year’s income. When taking in life insurance products, one can get a tax deduction on the premium paid under section 80C of the Income tax Act, 1961 within the overall limit of Rs1.50 lakh each year. In this segment, term plans get cost less and offer valuable insurance cover, making you an ideal choice for life insurance as well as tax savings. While there are other forms of life insurance policies may consider only after your basic life protection need is met with. (Also read :Don’t buy Life Insurance, Buy adequate Cover!)

Wealth Creation

There is variety in the available tax savings options, where is the money being invested into the mandatory EPF contribution till retirement, Public provident fund (PPF) that has a 15 year lock in, savings in five year fixed deposits, National Saving Certificate (NSC), and the Senior Citizens’ Saving Scheme that offer fixed return that barely manage to match the inflation. Most taxpayers would keep increasing their PF contributions without realizing its place will only add to debt allocation in their overall asset allocation despite increasing the limit of tax deduction from Rs1 lakh to 1.50 lakh. I strongly feel that the focus on too many fixed return instruments within the Section 80C limit has leaving very little room to invest into equity and averse to equity. This is a matter of concern as equity is the one asset class that the builds wealth in the long run, which is the top of the hierarchy of financial needs, is wealth creation and, the choice of instrument to build wealth is pretty limited. The limited choice on investments makes for a strong case to consider the ELSS.

The Equity linked saving option (ELSS) among instruments in which investments qualify for tax deductions under section 80C of the Income Tax Act is a superior option, which also suits the long-term investment goals of taxpayers when used deftly. It is a mutual fund, which invests 65 percent or more of its assets in equity and equity-related products to have a three year lock-in, which is the shortest lock-in among all tax saving option in compared to the five year lock-in that comes in case of most fixed return investments. Equating the ELSS to five year bank FDs when it comes to claiming tax deductions is an opportunity loss that history suggests that the long-term trend in equity investment has been positive. Given the inherent volatility in the short-term ups and downs of equity markets, the time horizon for investment in ELSS should typically be 5-7 years. (Also Read: Not investing in equities for the long term?)

Way to go

The hierarchy model is an optimum way to go about meaningfully using tax savings and aligning it to one’s financial needs. For instance, Mr. Shah has adopted this technique to build capital asset over the years with smart tax savings as well as its protection. You now have a new approach to save tax that’s certainly tastes the best of both the worlds i.e. Tax Savings and meeting the financial goals.

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