Taxes are a part of life as you pay them each moment, directly or indirectly, knowingly or unknowingly, and in almost every transaction you conduct. Whether you like it or not is immaterial. In other words, there is little you can do about taxes, as paying them is inevitable. However, you can continually strategize to minimize the impact of taxes within the ambit of rules set by the government. So, we list down the top strategies to protect income from taxes or reduce the tax burden.

Here you go…

1. Take the benefit of all the possible income tax deductions. Read about how to optimize investment and at the same time save taxes
2. Avoid short-term capital gain taxes by minimizing frequent portfolio changes. Aim for long-term gains, wherein full benefit of indexation is available, and even the tax rate is lower. Further equity long-term gains also have exemption up to Rs 1 Lakh as per the current income tax regulations
3. Maximize your investments in retirement benefits. These options include investment options like PPF, NPS, etc. The idea here is to make the most of these investments, and therefore the benefits
4. Remain updated on the tax-advantageous investment options and the limits thereof. For instance, savings bank account interest is tax-free up to Rs 10,000 under section 80 TTA. It may be worth leaving some amount in the savings bank account wherein the interest earned is tax-free. For instance, at the current interest rate of ~3.5%, you can keep an average of Rs 2.5-3L in your savings account, part of your emergency fund. The interest income will be tax-free. If we consider the marginal rate, the gross of tax return calculates to approx. 5% p.a., similar to income from liquid funds
5. Certain expenses qualify as tax-deductible, and you must claim the benefit wherever possible. For instance, housing rent allowance (HRA) deduction for the amount paid to rent an accommodation, cost incurred on medical treatment, etc.
6. Always create a secondary source of income, best if that is business income where the regulations allow you to deduct operating expenses
7. Contribute to social causes as those can be tax-effective as well. Plan your donations carefully so that you can optimize the tax impact by still keeping charity at the forefront

Tax planning is a journey, and not a destination

Tax planning is a long course, and you will always understand byte by byte. But, in a nutshell, optimizing tax costs is all about augmenting the tax advantages. In other words, the idea is to invest in assets that earn you decent returns. And at the same time, income generated from those assets or gains on asset sale minimizes the tax liability.

What tactics can a middle-class family use to save money?

Let us take a step back before we can answer this question. Why does one ever want to save money? The answer is simple, for the better future of the family, including self.

Is that it? It may sound straightforward, but there is more to this simple answer. In other words, the reference is to financial freedom or financial independence.

Financial freedom is more than just being able to meet expenses comfortably. For instance, it also means being able to pursue life goals without worrying about sustenance.

Having adequate passive income to be comfortably meet recurring living expenses is financial freedom. In other words, to be able to meet living expenses from income from investments without being actively engaged in work.

To be able to achieve financial freedom requires a focused approach. But, unfortunately, very few people are willing to plan meticulously and therefore fail.

So, what tactics can a middle-class family use to save and grow money?

1. Be an early investor, as there are significant advantages of early investing. More than anything else, the benefit of the power of compounding is substantial, and you will realize it over time
2. Determine the investment objectives and chalk-out a focused approach to achieve those goals. Split the target into immediate, medium-term and long-term and identify the investment options accordingly
3. Know your monthly budget. Although it sounds simple, you need a disciplined approach to get the hang of total expenses. However, the fundamental objective here is to know how much can you spend. Always define an expense target and remember the thumb rule – income left after savings should be the expenses, and not vice versa
4. Subscribe to health insurance and term insurance. Any unannounced event or arrival of medical uncertainty can significantly deteriorate the financial condition of a middle-class family. These insurance policies act as a shield
5. Save money regimentally and invest systematically into avenues that provide the best risk-adjusted returns. Income generated from these investments eventually grow over time and forms a respectable secondary source of income. For instance, investment in a house may earn a good rent yield along with capital appreciation over time
6. Avoid debt trap as the interest paid on debt can be a significant impediment to your financial progress. Similarly, restrict your use of credit cards, and certainly do not spend beyond what cannot get settled in the next payment cycle
7. Keep the family aware of the actual financial situation. Discuss your finances and remain transparent about the assets (and liabilities) with your spouse. Depending on the family structure and joint ownership status, you may also choose to discuss matters of financial importance with other family members like parents, siblings, children, etc., as the case may be
8. Investing and saving is a way of life. Do pass on these essential money lessons to children, so they acquire good financial habits early in their lives

Expenses are income less savings – The most important financial tip

Determine how much to save – the most obvious reference point is to set up savings as a percentage of total inflows. Alternatively, you can create your investment goals and determine savings to meet those objectives. As a thumb rule, plan to save anywhere between 20-40% of your total income.

Usually, the savings ratio improves as your life progress, though the curve may not be linear. In other words, generally, you would save more as your income advances.

Target to save 10% of your income from an early age as soon as you begin earning. Then, gradually as income rises, improve the saving-to-income (S2I) ratio. It is possible to double your savings % because usually, all else constant, the income grows faster than the expenses. Also, increasing your savings is more relevant because you are likely to take on more responsibilities in life. In the 35-45Yrs age bracket, your income rises, and so does the financial liabilities. But, you must maintain the S2I. In other words, the savings-to-income ratio can vary at different stages of life, but the ratio must be progressive. Read more about S2I here.

Finally, you can determine an appropriate savings ratio that applies to you. But, the larger point to note is that savings are never the residual of income after meeting the expenses. You must save adequate and manage costs from the income that is left.

In conclusion

We believe there are many legitimate ways of optimizing tax costs as per the legislation. These include tax-saving mutual funds, insurance premiums, house loan principal repayment and interest costs, donations, and several others. In other words, it is always possible to carve out an efficient way to optimize investments and avail tax benefits.

Split your assets based on the taxability of the returns they generate. In other words, generally speaking, you can bifurcate the assets into three parts – (i) assets where returns are taxable (annually), (ii) assets where tax is deferred (say, until an event occurs), and (iii) assets where the returns are tax-free. The classification helps you determine the right split, and therefore manage the tax on the income generated by these assets.

The best plan is to plan for tax incidence in every action you take. You do not get any brownie points to pay extra to the government exchequer.

The idea is not to avoid taxes or circumvent the law, as that is unrealistic and outside of the legal boundaries. Instead, the idea is to remain aware of possible opportunities to optimize the tax burden and take action accordingly.

To deal with taxes and efficiently planning tax costs can be cumbersome. If you are unsure, connect with your tax advisor for assistance and seek guidance on the way forward. Tax is a matter of expertise and a serious business.

Happy tax-savvy investing!

About the author

The author is a senior finance professional with over fifteen years of work experience in corporate finance. He has an affinity for matters relating to personal finance and investment management. Through his writing, the author wants to share his knowledge and understanding of the subject.

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Disclaimer

The author has used his knowledge, experience, and understanding of the subject and has exercised extreme caution to avoid possible mistakes. However, the author does not take any responsibility for any error that exists.

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Under any circumstances, the author shall not be liable for any views or analysis expressed in this note. Further, the opinions expressed are not binding on any authority or Court. We advise readers to consult their financial advisor for assistance in their specific case.