Know your money: Tax saving

WHY should you save taxes?

The answer is simple.

Every rupee you don’t spend is a rupee that stays in your bank account. Just the same way your salary lands with a ‘ka-ching’ in your account. Unfortunately a penny saved doesn’t make that wonderful sound we Pavlovian machines have come to associate with earning money, otherwise saving money would be so much easier.

Warren Buffett puts it differently:

I hope that I’ve convinced you. Now on to the brass tacks: How much can I save, and how do I do it?

Well, if you’re in the 20% tax bracket, (so your annual income is between Rs. 5 and 10 lakhs) then you’re paying out between 1 and 1.5 months salary in the form of taxes. You could save about half of that if you follow the instructions in this post.

Take a moment to get that in perspective. If you’re earning about Rs. 60000 a month, that’s Rs. 30000 you’ve got extra! Remember to treat it well. The money you earned from your salary is just the same as the money you earned from saving on your taxes.

There are about 10 different ways in which you can save taxes. I am going to make your life easier for you, and select the best, most sensible, four.

  1. Get a term life insurance

A term life insurance works like this: you pay a very small premium to get a very large insurance cover. In the case you die, your family gets the money. If you don’t die, you don’t get anything. Zero. Nada.

Surprisingly, very few people choose a term insurance, even though it is more beneficial to you in the long run. In a typical term plan, you would pay out a premium of Rs. 1000 per month, and get a cover of Rs. 1 Crore for 30 years. If you live to the end of the period, you’ve thrown away Rs. 3,60,000. But you’ve got your life with you in the bargain, and that’s priceless!

On the other hand, say you conk it half way though your policy. You’ve paid out Rs. 1,80,000, and you’re dead, so you don’t care much about what happens next. But your family has received a windfall of Rs. 1 Crore, so even though you’re not around anymore you’ve atleast taken care of their future.

Any other form of insurance policy has horrible terms for the customer and excellent terms for the insurer. More on this in a separate post.

2. Sock away some money in the Public Provident Fund (PPF)

I’ve written earlier about why PPF is still a great investment, and I still stand by my words. Here’s the two-line summary:

  • PPF is guaranteed by the Government of India, and is the only sovereign security that the common man can buy easily.
  • It pays out inflation beating interest rates.
  • It keeps you away from most of your money for the better part of 15 years.

Here’s a fact: if you invest Rs. 1.5 lakhs in your PPF account every year on the 1st of April, you will have, after 25 years, Rs. 1.18 crores! Assuming that the current interest rates continue, and the ceiling on yearly investment remains Rs. 1.50 lakhs.

3. Invest in an Equity Linked Savings Scheme (ELSS)

In simple words, that’s a mutual fund that has tax exemption. If I stumped you at mutual fund, that’s just a lot of people giving their money to one guy and asking him to invest their money on their behalf.

I’m not going to play the recommendation game here, but watch this space for an article on how to select mutual funds in the days to come.

4. Buy a house

There are two sides to making this decision. One is the financial and tax saving side, and the other is the lifestyle side.

The math is also not as easy as it seems, because most people reading this will be buying a house on loan. This is how the math works when you take a loan:

  • You can knock off upto Rs. 1.50 lakhs out of the principal that you pay in a year.
  • You can knock off upto Rs.2 lakhs out of the interest that you pay in a year.

Sounds great, right? But people fail to factor this:

  • for every Rs. 100 that you borrow at the current 8% rates of interest for the next 15 years, you will pay out Rs. 83 in the form of interest. At the end of the period, you will own an asset which may or may not be worth the amount you spent on it.

Also, you’re burning big money in the form of interest payments so you can save small money in the form of tax rebates.

Its important to remember that there is a lifestyle part to this, which obviously defies calculation. People choose stability, a home for the years to come, a place where their children can grow up, and so much more. These are the things which defy spreadsheets!

So there you go! Some may think that this is a badly timed post, because who wants to save taxes in the beginning of the financial year? Well, if you remember the lesson from the PPF example, the important thing to becoming rich is consistency.

Have a great financial year, readers!