It’s the start of financial year! How MFs can help in tax planning
It is the season to pay taxes – it is that time of the year again when you berate yourself for relegating your tax filing for the last minute, accept that it was a terrible mistake and that you would not procrastinate planning your taxes in the coming financial year. It is also that time when the new financial year starts and you have to review your financial strategies and fine tune it to your goals and requirements.
Many people end up making knee-jerk investment decisions at the end of the financial year to reduce their tax burden which may backfire – yes, you may be able to save taxes but the investment may not contribute in any way towards achieving your goals or it may not be aligned with your investment ideals. The right approach to tax planning is imperative so that you can lower your tax obligations while ensuring your wealth creation objectives. Hence, the beginning of the new financial year is the best time to have your investment pathway laid out for the year without forgetting taxation. Here are a few exercises you should undertake as an investor as the new financial year commences.
Analyse your goals
This is a good time to map your financial goals with the progress you would have made till now and to add new goals or eliminate older ones. It is also advisable to assess if you need to pump in additional funds for your goals due to inflation or other factors. For instance, if your goal is to buy a vehicle this year, it is possible the prices may have increased compared to the price spectrum that you would have envisaged when you started investing for it. In this case, you will have to recalculate the amount you need to invest without having to postpone your goals. Also, if you are anticipating a major life event, such as going back to college or raising a family, you will need to factor in the financial elements of those changes as well in your money plan.
Banks deduct taxes before paying interest to depositors which is known as Tax Deducted as Source (TDS). TDS is levied when your interest income is more than Rs.40,000 in a year ( ₹50,000 for senior citizens). Banks add deposits held in all its branches to calculate this limit and in case your income is less than the exempted limit and you do not fall in the tax net, to avoid TDS, you will have to submit the Forms 15G or 15H to your bank at the beginning of the financial year. Make sure you understand the rules pertaining to Forms 15G and 15H, to avoid penalty. Form 15G is for citizens below 60 years of age and 15H is for senior citizens. You can file 15G if the tax on your total income is nil and the total interest income subject for the year is less than the basic exemption limit of that year, which is Rs.2.5 lakh for financial year 2020-21. Form 15H can be filed by senior citizens if the aggregate tax is nil. Both these firms have to be filed fresh every year.
Tax saving investments
Investing in tax saving instruments can go a long way in fulfilling wealth creation objectives while softening the blow of your tax obligations. Traditionally most taxpayers have picked Fixed Income or Debt Products especially PPF, EPF under this section for tax saving purposes. Equity-linked savings scheme (ELSS) mutual funds however provide an edge since they offer the best of both worlds - tax savings as well as capital appreciation through equity investments. ELSS is a tax-saving mutual fund scheme that invests in equity markets.
When it comes to tax advantages, investors can avail tax benefits under Section 80C of the Income Tax and investments of upto ₹1.5 lakh are eligible for tax deductions under Section 80C. ELSS have a shorter lock-in period of three years compared to most tax-saving instruments. It is important to remember that the lock-in rule is applicable to all the units of the mutual fund which means you can withdraw your investments when the units you bought have completed three years regardless of their value at the time of redemption. When you make a lumpsum investment, you can withdraw your money once 36 months have elapsed but in the case of SIP investments, each investment made through SIP will have to remain invested for three years before you can withdraw the money.
Post the lock-in period, you can either withdraw your investment or you can continue to stay invested. The returns generated from ELSS funds attract a long-term capital gains tax at 10 per cent if the gains are higher than ₹1, 00,000 in a year.
What makes mutual fund investments better than other tax saving avenues is the fact the gains in mutual funds are taxed only when the fund is sold. There is no tax on notional gains as opposed to say tax-saving FDs where taxes are levied on accrued interest. Also, the convenience of SIP investments coupled with the potential of high returns offered by equity investments make this a great portfolio addition.
• Before choosing an ELSS funds, make sure to assess if it matches with your risk appetite.
• Start collecting documents that you would need for ITR filing from now itself to avoid a mayhem-like situation later on.
• Your financial review for the year ahead should also include a review of your existing insurance plans.
This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund