I earn Rs 5 lakh annually from pension. What tax planning options should I consider?
— Ramesh Chandra
To be in the income tax bracket in retirement with taxable retirement income can be unnerving and irksome. There is little that you can do to change that state. However, with prudent planning and action, you can optimise your tax liability without being impacted unduly by it. You still have over a month to plan your taxes in this financial year, but do keep in mind that this year March 31 falls on a Sunday, which means you have to act by March 29 at the earliest. One of the biggest problems for most taxpayers is their inability to see through the available investments and selecting an option that best meets their needs. Instead, most taxpayers land up selecting whatever is offered by a salesperson as a tax saving investment option. For a variety of reasons, savers tend to make hasty and poor decisions while choosing their tax-saving investments. For one, many of those who wait till the end of the year are those who don't make any discretionary investments other than the tax-savings. They are inexperienced in this whole activity and make a foray into investing only once a year, and generally fall prey to the first salesman who comes along. As long as an investment serves the primary motive of saving tax, they feel that the immediate job is done.
The fixed fixation
Like many other retirees, you too would be tempted to consider saving and investing in an instrument which is fixed in nature. Bank fixed deposit, NSC or PPF are all fixed return instruments with a 5-15 year lock-in range. These also offer fixed returns varying from 8.5 to 8.9 per cent annually. Moreover, the interest earned by these schemes, barring the PPF, are taxable as they are added to your income. Yet, there is a tendency amongst several risk averse and the retired who shun equity without realising the impact of inflation on these fixed return instruments. When adjusted to inflation, these tax saving options tend to post negative returns on most occasions.
To make tax savings and investments work for you, you need to adopt the approach where tax-saving is an investment first and a tax-saver later. After all, equity is the only asset class to beat inflation in the long run.
For many, the investment that should make most sense is in an equity-linked savings scheme (ELSS). These are mutual fund schemes which invest a minimum 65 per cent in equity and are notified to avail tax benefits under Section 80C up to Rs 1 lakh in a financial year. These mutual funds have a 3-year lock-in, which is the least among the available investment instruments that qualify for tax savings. What's more, ELSS returns are tax-free like all long-term equity returns, which means there is no tax on the profits or gains after the 3-year lock-in with these investments. If you get into a cycle of making investments into ELSS every year for a 3-year period, it gets into an automatic mode of providing you with tax savings investment, without any fresh investments.
This article was originally published on March 04, 2013.
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