Important Facts To Know About Personal Tax Planning

The Importance of Tax Planning

Many people use the term “tax planning,” but it is often misunderstood. It is the art of learning how to manage your affairs in ways that postpone or avoid taxes. Skilled tax planning means more money to save and invest, and it can make the tax season more of a financial boost instead of a financial burden. As explained well by Wealth Plan: “tax planning means either deferring or avoiding taxes by taking full advantage of the beneficial tax-law provisions, increasing tax deductions and tax credits, and by making good use of all applicable breaks that are available under the Internal Revenue Code.”

Strategies are typically designed and employed to achieve goals–a series of steps undertaken to accomplish an intended end. Of course, strategies within the realm of tax planning are undertaken to achieve financial goals primarily, but they are also employed to achieve business goals. If your tax planning strategies are effective, they should successfully accomplish, or at least address, the following goals:

  1. Lower your amount of taxable income
  2. Reduce the rate at which you are taxed
  3. Empower you to control when taxes get paid
  4. Ensure you get all credits available to you
  5. Put you in charge of the Alternate Minimum Tax

Note the following sample of strategies intended to reduce one’s tax liability, as noted by Cash Cow:

  • Maximize Retirement Contributions: Deferral of taxation is one of the most common and useful tax strategies for individuals who are currently in a high tax bracket, but if you follow this path anticipate being in a lower tax bracket at some point in the future when withdrawals (distributions) are taken.
  • Harvest Investment Losses: You can offset unlimited investment gains, and up to $3,000 of ordinary income each year by selling your investments that have lost value. If your losses exceed your gains and the $3,000 of ordinary income, you can carry them over to be used in future tax years.
  • Consider Charitable Gifts: This strategy is only useful if you can itemize your tax deductions (most often due to mortgage interest deductions), and plan on making donations. Appreciated assets are some of the most tax-efficient charitable donations. Donating these assets will allow you to avoid paying capital gains on the appreciation.
  • Invest In Municipal Bonds: Some high income earners are now subject to the 3.8% Medicare surtax on all investment income. Municipal bonds avoid this additional tax, and typically avoid all Federal and State income taxes. That means the tax equivalent yield (the yield an investor would require from a taxable bond) has increased for those taxpayers, making muni-bonds more attractive.


Types of Tax Planning and Management

Now that you’ve seen what is tax planning, and the difference between tax planning and management, let’s understand the types. There are essentially four methods here’s a summary of each.

Short Range Tax Planning:

This type of tax planning has a limited objective or aim. Investors will often rush to invest toward the end of the financial year. This usually happens when there is a change in the taxpayer’s financial situation. For example, you get a promotion and a raise during a financial year. Your salary structure will obviously not be the same as the previous year. You realise, your taxable income is now higher. So, 3 to 6 months before your taxes are due, you look for investment options. These can be found mostly under section 80C. You’ll be requested to submit income tax proofs, if you have chosen any compliant financial product, to save tax, under this section.

Long Range Tax Planning:

In this method, you’re essentially taking calculated tax saving decisions, at the beginning of a financial year. The aim is to reduce tax liability for the long-term. For example, taking a home loan, or, an education loan. Another way to reduce your tax liability is, by transferring shares, or assets with family. If their taxable income is lower than yours, they can be eligible for tax benefits.

Permissive Tax Planning:

Through this method, you’re optimising each and every section of the Income Tax Act of India—1961. You need to be within the legal framework of compliance. Utilising all the sections legally, doesn’t mean you’re avoiding taxes. It simply means, you’re being smart about reducing your tax liability.

Purposive Tax Planning:

Here, you’re planning you have a specific purpose to save taxes. This method needs a detailed evaluation of investment options, assets, etc. At times, it may even require a complete restructuring of your personal finances, to reduce your tax liability.


How to get started?

Anyone can start planning their taxes in a few simple steps:

  1. Start by taking your total income into account. This is the starting point of the process and requires you to accurately assess your annual and monthly income.
  2. Evaluate the taxable aspects of your income. Housing and rent allowances included in the salary on top of base pay are not taxable. However, profits made from investments could add to taxable income. Therefore, understanding one’s taxable income is a requisite to be able to plan taxes.
  3. Make use of deductions to reduce the total taxable income. This can be done by structuring salary and proper planning of investments. For example, interest from a fixed deposit is taxed at the same rate as income tax, while a debt fund held over e years is taxed at 20%. So if you fall in the 30% tax bracket against the taxable income of 10 lakhs and above, debt funds are a more tax-friendly option.
  4. Invest in tax-saving instruments. There exists a wide range of deductions available to eligible taxpayers in Sections 80C through 80U of the Income Tax Act, 1961. Other options such as deductions and tax credits are listed under the Income Tax Act, 1961. Investment options include Provident Public Fund (PPF), Equity Linked Saving Schemes (ELSS) in mutual funds, National Saving Certificates (NSC) or 5-year bank deposits. Life insurance, health insurance premium and home loan payments can let you avail tax savings.


You Need to Consider the Importance of Tax Planning

If you’re reading this and fall into the crowd that hasn’t been considering their taxes in retirement because you were unaware, you’re now aware! If you aren’t confident about what you need to do next, keep reading. The first thing you need to do if you haven’t looked into the importance of tax planning in retirement is to find a trusted professional to help you. Many of you may already have a financial advisor and a CPA. That’s great! However, are they working together to make sure your accounts get utilized in the most tax-efficient manner? If not, maybe they need to be in contact.

You see, most CPAs don’t have the luxury of working directly with the individual planning someone’s retirement and investment plans. Though allowing the two to work together to build a plan that best manages your account over time considering the tax impact year over year is extremely advantageous.

Many Factors Involved in Tax Planning for Retirement

Tax planning in retirement carries more importance when you consider just how many factors impact your taxes.

  • Social Security – “But wait, that’s tax-free, right?” Not always.
  • Required Minimum Distributions – “We don’t have them in 2020, who cares.” You should be looking much further down the road than just 2020.
  • Charitable Giving like Qualified Charitable Distributions – “Why can’t I just give money straight to a charity? Why complicate it?” You could be saving yourself in taxes, that’s why!
  • Roth Conversions– They aren’t for everyone, but they may be right for you!


Investment Avenues for Tax Saving

Under Section 80 C one can invest in PPF, NSC, Bank FDs, Life Insurance & ELSS are various investment instruments eligible for tax saving. Amongst them ELSS enjoys the shortest lock – in period of 3 Years. Also Equity Linked Saving Schemes (ELSS) allows one to benefit from the long term growth potential of equities and offers the facility to invest the amount systematically: Systematic Investment Plan (SIP)

Systematic Investment Plan (SIP): A Smart Way to Save Taxes too!

  • SIP is a strategy whereby an investor commits to invest a fixed amount at specified intervals.
  • SIP allows one to achieve tax saving in a systematic & hassle free manner: As a fixed amount gets invested automatically each month, the investor does not have to worry about making hasty last-minute lumpsum investments for saving tax.
  • Law of Averaging at work – Rupee Cost Averaging at its best: investing the same amount on a regular basis will lead to one getting more units when price is low and one getting less units in case price is high.
  • Small Ticket Sizes do not impact the wallet too!
  • Focus on consistent & continuous investments – Fixed Money for Fixed Period of time to benefit from market volatility.
  • Imparts Discipline in investing – The most needed quality for a long term investor.
  • Each SIP would attract a 3 year lock-in period.