Are Your Tax-Saving Investments a Suitable Fit For Your Financial Plan?

The government encourages taxpayers to make long-term investments that qualify for tax credits under various sections of the Income Tax Act. Individuals should take advantage of this option to reduce their annual tax liability. Though it is not required, it is recommended that you use this facility since it provides two benefits: Lower taxes and long-term investments. Given the maximum allowable limit accessible under various I-T sections, there is no way to reduce tax outflow beyond a certain amount. Sections such as 80C (maximum investment of Rs 1.5 lakh per year), 80CCD (extra deduction of Rs 50,000 by investing in NPS), and 80D (maximum deduction allowed under medical insurance of Rs 1 lakh) are frequently used to lower income tax.

To get the most out of your tax-saving investments, they must be integrated into your overall financial plan and contribute to your financial goals. So, if you're unsure how to determine which tax-saving investment is ideal for you and if it fits your plan, don't panic. In this article, we'll help you comprehend the points to keep in mind as you plan your taxes for the financial year 2022-23.

Recently, I received a call from my friend "Rishi" after finishing the hassle of tax filing, he was looking forward to new tax-saving investments for the FY2022-23. He said, "Mitali, in the previous year, I invested in tax-saving instruments which are backed by the government, but those investments could only offer returns in a certain range and help me reduce my taxes. Whereas my friends invested in Equity Linked Savings Scheme (ELSS) mutual funds, which offer them decent returns along with reducing their tax obligations. So, with the beginning of the financial year, even I am planning to switch to market-linked tax-saving instruments that could offer me significant returns and not just save tax."

To which I responded, "Rishi, you need to understand that a good tax-saving investment should align with your risk tolerance, and you should not consider investing in tax-saving instruments based on any advice from your friends or relatives. Selecting the right tax-saving investments may not come easy for everyone. While some tax-saving instruments are market-linked such as ELSS, the return generated is not fixed (rather, it depends on the performance of the underlying securities such as equity or debt), there are those traditional tax-saving instruments like PPF, NSC, etc. that come with assured returns."

Rishi replied, "So while investing in tax-saving instruments, I need to assess my risk profile first and then invest as per the suitability. I am a little confused. Could you please explain in detail what exactly are the points to be considered while tax planning?"

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Invest in Tax-Saving Instruments Based on Your Risk Appetite...

Choosing between traditional tax-saving instruments and market-linked avenues will be largely determined by one's risk appetite and other considerations such as liquidity. Those with a larger-risk appetite will have more 'unpredictable' goods in their portfolios, such as equity, whereas risk-averse investors would seek more stable investments. Risk-averse investors would avoid putting their money into volatile investments with variable returns.

In simple words, risk tolerance is the percentage of total wealth invested in equities. It is the degree of variance in investment returns that an investor is willing to withstand in their financial plan. So, first and foremost, you should assess your risk tolerance and select an investment mix. Examine your existing tax-saving investments before investing in new tax-saving instruments. This will allow you to determine the potential for greater tax savings by growing your assets.

When it comes to tax planning, it's critical to focus on the appropriate product that fits your risk profile and investment horizon while also saving you taxes. Due to the long investing horizon accessible to you when you're young, you're more likely to have a high-risk appetite. An ELSS makes a lot more sense than a PPF if you want to build wealth over the long run. You will not only build greater wealth over time, but you will also be more tax-efficient in terms of exemptions and tax refunds.

Align your Tax Planning with your Financial Plan...

Tax-saving investments are important for financial planning and growth since they provide tax benefits under Sections 80C and 80CCC of the Income Tax Act of India, as well as serve as a safety net for unforeseen crises.

When your tax strategy is in line with your overall financial strategy, your tax plan is immediately linked with your target investment mix. It ensures that your tax and investment planning are aligned to achieve the same financial goals.

When it comes to investment planning, be sure that your investment mix includes tax-saving products. To establish a solid financial plan that leads to improved financial well-being, it's critical to complement tax planning with investment planning. Investing in suitable tax-saving instruments as part of your investment planning ensures that your tax liabilities are reduced while also providing you with better risk-adjusted returns.

For example, assume that your risk tolerance is 60:40 in equity & debt. You may allocate 60% of your assets in your portfolio into equity products at any given time. Check your existing Asset allocation before making a new tax-saving investment. This will give you an idea of what kind of investment you should make so that it fits into your desired investment mix. Assume your current equity and debt allocation is 30:70, and your ideal allocation is 60:40. In that situation, you could invest in ELSS mutual funds, which offer market-linked returns but are riskier due to equities' volatility. This will not only save you money on taxes, but it will also help you get closer to your ideal investment mix.

[Read: 3 Best ELSS for 2022 - Top Performing Tax Saving Funds to Save Tax in 2022]

Given that, don't look at tax planning as distinct from your financial plan. Remember that tax efficiency is one of the four pillars of your financial plan, and building a tax-efficient portfolio can significantly increase your long-term wealth creation potential. This is only achievable if your tax planning is in sync with your overall financial plan.

As a result, focusing on the tax effectiveness of your financial plan and ensuring that your tax-saving investments are suitable for your financial plan makes your job a lot easier. You are aware of how much tax you need to save, so you can arrange your investment mix accordingly. In fact, when market conditions are favourable, it may make sense to pay off your taxes and keep your money invested in high-return investments. However, these types of trade-offs are only conceivable when your tax plan is in sync with your financial plan.

Therefore, as you begin tax planning for FY2022-23, keep in mind that it's far more vital to make sure your tax-saving investments are inline with your financial plan.

However if you are not sure about how to exercise your tax planning, save yourself from the last-minute stress and initiate your tax planning with the help of PersonalFN's Definitive Guide to Select ELSS (Edition 2022).

This Guide will show you how picking a worthy ELSS, a tax saving mutual fund, that could potentially maximise your wealth and act as an effective tool for tax planning. It includes:

• Why ELSS is a worthy option for tax planning

• Mistakes to avoid while investing in ELSS

• How to select the best ELSS for tax planning

• How have ELSS performed as a category

• Some of the best ELSS to invest in

• Who should consider investing in ELSS

• How should one go about investing in ELSS

If you are looking to exercise your tax plan and invest in ELSS funds towards the end of FY2020-21, then Subscribe now! To PersonalFN's Definitive Guide to Select ELSS (Edition 2022).

Warm Regards,
Mitali Dhoke
Jr. Research Analyst