Normally, the last 2 months of the year is when most tax payers rush to invest in tax saving products. There is a virtual rush to claim the full benefits of Section 80C, Section 80D and investing in tax free bonds. Before you invest in any of these tax saving instruments you need to ask yourself a simple question; does this fit into my overall financial plan? This will ensure that your tax planning is not a stand-alone exercise but syncs with your overall financial plan.
Your financial plan is the starting point towards your medium term and long term goals. The financial plan is based on 4 basic premises; maximizing returns, minimizing risk, ensuring adequate liquidity and creating tax efficiency. The fourth pillar of financial planning is what tax planning is all about. Syncing tax saving and financial plan is at the core of planning your taxes. This will ensure that your overall planning is in sync. Tax planning and financial planning cannot be seen as distinct activities and weaving your tax plan into your financial plan ensures that you are able to fully leverage your financial resources. Here is a tax and financial planning guide on why to sync these two activities. There are 5 key reasons..
Moving towards a larger financial pathway
Your financial plan is your pathway to your long term goals and your medium term goals. Be it your retirement, your child’s education, your child’s wedding, margin money for your apartment; all these require planning. More importantly, they also require resources and hence they need to be planned for. Obviously, if you earn a very low rate of return or if your returns are eaten away by taxes, you are unlikely to reach your financial goals. The best way to attain your milestones is to make your money work much harder in post-tax terms. That means your year tax planning exercise is just a part and parcel of your larger financial plan. It is important not to lose this perspective.
Aligning your cash flows with your tax planning
When you make your financial plan, it is all about your cash flows. You typically do a SIP or systematic investment plan to get the best of rupee cost averaging. More importantly, since your earnings are periodic in nature, your outflows for investments also need to be periodic. That is what aligning your cash flows is all-about? If you do not align your tax plan with your larger financial plan then the two could actually be at cross purposes. Also, you may end up allocating regular funds for your financial plan and then go around searching for funds towards the end of the year for planning your taxes. That would be an unproductive way to do your tax planning.
Focus on the right products for your needs
When you plan your taxes, it is essential to focus on the right product. If you are young and are looking to create wealth over the long term, then an ELSS makes a lot more sense than a PPF. You are not only going to create more wealth in the long term but also it will be more tax efficient in terms of exemptions and the taxation of returns. When your tax plan is aligned with your overall financial plan, then automatically your tax plan gets aligned to your target investment mix. It ensures that your tax planning and your financial planning are working towards the same goal.
Avoid over investment or under investment in an asset class
A lot of us do not give adequate weightage to this point. Let us understand this with an example. Your financial plan dictates that your exposure to debt should be to the tune of 25% only. While you have allocated funds to debt mutual funds, your exposure to PPF is also adding to your debt component. At the end of 10 years you may realize that your exposure to debt has inadvertently gone up to 40% and hence it has become sub-optimal. At a time when you could have made time work in your favour, you have missed out the possibilities of creating wealth through equities. That kind of a situation can be avoided if the tax plan is synced with the overall financial plan.
Every investment decision has to be a part of your financial plan
That is the bottom-line! Don’t look at tax planning as distinct from your financial plan. Remember, your tax efficiency is one of the four pillars of your financial plan. By creating a tax efficient portfolio you can substantially enhance your wealth creation potential over the long term. That is possible only if you have aligned your tax planning to your overall financial plan. When you focus on tax efficiency of your financial plan, your job becomes a lot simpler. You know how much tax you need to save and your investment mix can be planned accordingly. In fact, there are times when it makes more economic sense to pay off your tax and let your money stay invested in high return investments when the conditions are favouring you. These kinds of trade-offs are only possible when your tax plan is aligned to your financial plan.
So the next time before you embark upon your tax planning; remember it is a lot more important to ensure that it actually aligns with your long term financial plan!
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