Here is a set of simple steps that might help young earners minimise their taxes and take control of their financial life.
This post is based on a request from one of my students who started out on an IT job some months ago.
Tax planning - a set of actions designed to save tax – is how most young earners get interested personal finance.
Unfortunately, most of them screw up their financial life right at the start, by buying utterly unsuitable products all in the name of ‘tax saving investments’!
To plan, one must recognise that taxes saving instruments share some common traits:
Instruments that offer ‘pure’ insurance for a fee
- Term life insurance on a contract that runs for a few years with yearly renewals
- Health insurance typically on yearly contract and renewals
Instruments that offer a ‘return’
- They have a lock-in period of a few years – 3 for ELSS mutual funds, 15 in the case of PPF and few years to decades in the case of insurance plans (ULIP, money-back, endowments, pension plan, child plan etc.).
- Most of them require you to pay for a certain number of years- 15 in the case of PPF and few years to decades in the case of insurance plans.
(A) Choose pure insurance products first!
(B) Among instruments that offer a ‘return’, choose one with minimum lock-period with no obligation to make future payments.
Tax planning Cheat sheet
The following is independent of tax section (80C/80D) sub-limits!
Section 80 C:
1. Account for EPF contributions – the obvious and automatic choice.
2. Buy pure term life insurance - Guideline (A)
Surprised! Don’t be. Get term insurance for as high an amount as possible for about 25-30 years. Online policies are quite cheap irrespective of the insurer for young earners.
So get as high a cover as they would offer and name your parents as nominees (even if they are financially independent!). Later you can change it to your spouse or kids.
Here are some things to do after you get a term plan!
3. Lump sum investment in a ELSS mutual fund - Guideline (B)
At 3 years, they offer the lowest lock- period. There is no obligation for you to invest the next financial year, provided you don’t setup a SIP (don’t!)
Get yourself an online account from an AMC and invest –a few times a year on market dips.
You can use this step-by-step guide to select a ‘good’ ELSS fund
Section 80 D
4. Individual health insurance cover for self and parents - Guideline (A)
Does not matter if your employer offers one. Just buy one for yourself and your parents for as high a cover as you can afford. Increase the sum insured each year by as much as possible.
5. Identify a good charity and sponsor them. Yes, you can save tax too but that is not important.
That is it! Simple steps to ensure you don’t get your financial life in a tangle.
With that behind you, you can begin to
- list your financial goals,
- tag your ELSS investments to one of your long-term goals
- minimise your expenses
- invest as much as you can in equity instruments