FOR many, Section 80C of the Income Tax Act forms the cornerstone of their tax saving strategy. The section incorporates tax breaks for so many varied activities that our lawmakers wish to encourage that it has a different connotation for different age groups or different income levels. The tax breaks for long-term investments range from zero risk investments like PPF to risky options like equity-linked savings scheme (ELSS). The section encourages spending for insurance protection and it also provides relief for those spending on their dependents. Therefore, there is no ‘one-size-fitsall’ formula for this Section. The only way to go about planning taxes is to define your age and income group and choose the appropriate options.
AGE: 25 YEARS
Gross taxable income: Rs 3,00,000
If an individual, who earns a taxable annual income of Rs 3 lakh with the mandatory provident fund deduction of Rs 20,000 per year, does not take any tax-saving measures except paying a life insurance premium of Rs 10,000, he might have to shell out Rs 12,360 in taxes. But, if he invests Rs 1 lakh under section 80C and buys a health cover, entailing a premium of Rs 10,000, he can bring down his tax payable to Rs 4,120. In the case of women, the tax liability will be merely Rs 1,030, since the threshold exemption limit for women is Rs 1,80,000. This apart, if she is repaying an education loan, the tax liability might be nil as the entire interest amount paid on the loan is exempt under section 80E. Also, if the individual does not have any dependents, it would be prudent to reconsider the need for life insurance. While many financial planners recommend ELSS for people in this age group, others contend that even public provident fund (PPF) is an attractive avenue. “Our recommendation for this category is that they should invest 50% in ELSS and 50% in PPF,” said financial planner Amar Pandit.
AGE: 30 YEARS
Gross taxable income: Rs 5,00,000
If an individual’s taxable income is around Rs 5 lakh per annum, he will fall in the next bracket — the one attracting a tax rate of 20% (Assumptions: PF contribution of Rs 36,000 and life insurance premium of Rs 10,000). However, proper tax planning could result in considerable savings. Against paying a tax of Rs 47,174 before investing in instruments under 80C and paying a health insurance premium of Rs 15,000, he will end up paying just Rs 32,960. Since most individuals may not have to shoulder any major responsibilities at this age, again, a combination of ELSS and PPF could be a good bet. “A point to be borne in mind here is that all investment decisions need to be taken after evaluating individual needs and risk profile, and not merely on the basis of age and income level,” pointed out financial planner Kartik Jhaveri.
AGE: 35 YEARS
Gross taxable income: Rs 7,00,000
Here, if an individual (married with kids) has availed of a home loan this year, the opportunities for maximising the tax breaks are immense. If he is servicing a home loan of Rs 40 lakh, he can claim deductions on interest and principal repaid. In fact, the amount of principal repaid itself will help in exhausting the entire Rs 1 lakh limit. Besides, the deduction of Rs 1,50,000 for interest paid on home loan will lower his tax liability further. The combined impact of all deductions will be huge: from paying a tax of Rs 96,820 — prior to availing of these exemptions, the tax payable will come down to Rs 43,260. In case he has not opted for a home loan, he can claim deductions under section 80C for tuition fee paid for his children’s education.
AGE: 40 YEARS
Gross taxable income: Rs 10,00,000
At these income levels, the tax-saving options are almost similar to the Rs 7,00,000 bracket. A home loan repayment would circumvent the need for making any investments under section 80C. Exemptions claimed under various sections (80C, 80D and 24) would result in the tax payable decreasing from Rs 1,83,340 to Rs 1,29,265. If the individual has started making contribution to PPF since the age 25, the mandatory 15-year lock-in tenure would have come to an end. Under these circumstances, if he is not repaying his home loan and consequently, is scouting for avenues to invest under section 80C, he can consider extending the PPF tenure for another five years. For senior citizens, the income up to Rs 2,25,000 per annum is exempt from tax. For this category of assessees, experts recommend avoiding instruments entailing a prolonged lock-in period. However, the 9% senior citizens scheme and post office time deposits (investments under which are deductible under section 80C) are recommended.
Towards the end of every financial year, tax payers look at ways to reduce their income tax liability. Many end up spreading their investments across various tax saving schemes and end up buying some life insurance as well. While buying the focus is more often than not on how much money to allocated towards the premium rather than the sum assured.
But a life insurance policy can be relevant over a long-period of time only if there is a scientific approach in determining the sum insured. Fortunately for buyers, this approach can be distilled into simple to follow thumb rules while deciding on the extent of cover.
INCOME MULTIPLE RULE
You should buy life insurance cover for a sum which is equal to a certain multiple of your annual net income. The multiples are given in the table. Income here refers to net income, which means, the residue of your salary after paying for your personal expenditures. This method is one of the simplest methods of ascertaining your need for life insurance.
For example — Rajan, a 30 year old shopkeeper who earns Rs
25,000 per month and spends Rs 2,500 towards personal expenditure per month, should buy life insurance worth ( (25000-2500)*12) *12 = Rs 32,40,000 on the lower side.
PREMIUM AS % OF INCOME
For those who have to prioritise their spending, another way to budget for insurance is to use the benchmark allocating 6% of gross income towards buying life protection. To this 6% an additional 1% should be added for each dependants. A point to be noted is that life protection here refers to pure term insurance – policies which provide only death cover without any savings element. There are ULIPs and other investment plans with high premium but only the money going toward premium should be taken into account.
In the above example, if we assume that Rajan has two dependants on him, then the premium payable towards life insurance is [ (6% * 25000) + (2 * 1% * 25000)] *12 = Rs 24000. How much insurance cover Rajan gets would depend on the cost of insurance. Companies often buy group insurance cover for employees using this yardstick.
The above two methods are easy to use as there are no complex computations and they bring forth a decent estimate of your need. Those who want to be precise can use methods such as human life value (HLV), capital retention or capital estimation to ascertain their insurance needs. The biggest flaw with the simpler methods is they do not take into situations specific to individuals and variables such as inflation.
Human life value is a better method than the rules of thumb. An individual’s HLV is equal to a sum which can generate his annual income after subtracting the expenses incurred by him for personal consumption over his working life at an expected rate of interest. One can also include variables such as inflation and increase in income to reach a precise value. Many life insurance companies and financial planning websites offer calculators to that effect. Whatever be the tool, there is a need to clearly understand the need of insurance and ascertain the quantum. Go for an amount that would fetch you peace of mind and more important you can afford it, not just in first year, but for the entire term of the policy.