Tax-saving has been the top-most, at times, the only objective for countless investors in our country for ages. The pressure to reduce income tax outgo by making eligible investments and insurance purchases have often taken precedence over an investor’s financial goal requirements, risk appetite and liquidity prerequisites. Many a time such last-minute tax-saving investments proved counterproductive to the investors’ wealth-creation goals. Similarly, many used to end up buying surplus insurance policies or complicated endowment plans that fetched low returns -- just to save tax.
However, it is in this context that Finance Minister Nirmala Sitharaman’s announcement to launch a new, optional personal tax regime in her 2020 Budget speech becomes hugely significant. But before I explain how and why, let’s first understand what the new tax system entails and what all needs to be factored in to make informed decisions about investments and insurance.
An option to reduce tax outgo by forgoing deductions
Sitharaman announced in her second budget speech that from FY2020-21, taxpayers will have the option to either continue with their existing income tax-slab rates and benefit from established tax deductions, or avail the new, reduced tax-slab rates by forgoing all tax deductions. The move is to ensure taxpayers are left with more disposable income to boost consumer sentiment. And the reduced rates of the new tax regime are quite attractive: Income between Rs 5 lakh and Rs 7.5 lakh will now be taxed at 10 percent instead of 20 percent, income between Rs 7.5 lakh to Rs 10 lakh will now be taxed at 15 percent instead of 20 percent, income between Rs 10 lakh to Rs 12.5 lakh will now be taxed at 20 percent instead of 30 percent, and income between Rs 12.5 lakh to Rs 15 lakh will now be taxed at 25 percent instead of 30 percent. Income above Rs 15 lakh will continue to be taxed at 30 percent.
Those who wish to opt for the new tax regime can, hence, save a good amount in taxes if they are willing to give up on the deductions. Quoting Sitharaman’s example during her Budget speech, “a person earning Rs 15 lakh in a year and not availing any deductions, etc., will pay only Rs 1,95,000 as compared to Rs.2,73,000 in the old regime. Thus, his tax burden shall be reduced by Rs 78,000 in the new regime.” However, what you also need to see is how far you can stretch your tax savings through deductions. For example, at an income of Rs 15 lakh, if you availed a combined total deduction of Rs 3 lakh, your tax liabilities will fall to Rs 1.79 lakh. Hence, results will vary from one individual to another.
That being said, under the new regime, being freed from tax-saving compulsions can help you make investments better aligned with your financial goals or insurance requirements. You would not have to worry about meeting tax-deduction limits like Rs 1.5 lakh under Section 80C in the new tax regime. This, in fact, will help broaden the horizon for many investors as they would look to explore investment instruments that do not come with tax-saving benefits — like most market-linked products such as mutual funds. They will be free to invest wherever and however much they want to so that they meet their financial goals on time. Which is a great thing! But, it’s superlatively important to understand that…
Freedom must be exercised responsibly to maximise benefits
To maximise the benefits offered by the new, simplified tax regime, taxpayers must make good use of their increased tax savings. Moreover, they need to steer clear of certain costly mistakes that they may feel tempted to commit owing to the extra cash they save. I’ve discussed a few critical pointers they must consider if they want to opt for the new tax regime:
Invest freely based on the demands of your financial goals
It’s high time to analyse the requirements of your financial goals and chalk out an investment plan to achieve them on time without getting bogged down by tax-saving goals. Evaluate your income, risk appetite, age, and liquidity requirements and try to build a diversified investment plan. You are now free to explore new investment avenues that could accelerate your journey to meet your goals on time. Do not hesitate in consulting an investment advisor if you’re not clear on how to build your investment strategy.
Don’t stop investing because you don’t feel the need to do so anymore
Many have argued, and rightly so, that the old tax regime provides at least some direction to the common man’s investment goals. Smart and consistent investing is key to adequate wealth creation and timely fulfilment of life goals. Do not make the mistake of not investing if you opt for the new tax regime. The new system should, in fact, inspire you to make smarter and bigger investment decisions. Not the other way round.
Don’t ignore insurance just because there’s no tax benefit on it anymore
I have always opined that tax-saving should not be the primary consideration while buying insurance. Under the new tax system, you might not get tax benefits on insurance purchases, but that should not deter you from buying insurance. So, analyse your insurance requirements and continue with them nevertheless. For example, you should ideally buy a life insurance plan with a sum assured worth at least 10 times your annual income to protect the financial interests of your dependents, and a comprehensive health insurance policy worth at least Rs 7 lakh to prevent draining of your family’s savings while tackling a medical emergency.
Make use of added money to build an emergency fund or accelerate freedom from debt
The money you might save under the new tax regime could also be used to build or replenish your emergency fund to strengthen your finances in the face of an emergency like a sudden job loss. Ideally, an emergency fund should be worth at least 6 months of your expenses. Similarly, if you’re struggling with snowballing debt (like uncleared credit card dues), this extra cash may help you accelerate your debt clearing process.
In conclusion, it’s very important to prioritise how best to utilise the tax savings that the new tax system might offer. Taxpayers are now free to formulate better investment and insurance strategies that can help them make their dreams come true while consolidating their family’s financial interests. It’s also critical that they understand the pros and cons of each tax regime. The new regime may not provide higher tax savings to everyone. Therefore, for the best results, you must do the tax math using the deductions available to you.
