Learn the art of tax efficiency to supercharge your wealth-building journey.
Let’s start today’s article with a fundamental truth: while we all work to earn money, the real wisdom lies in the art of saving that money. Saving, however, can be challenging, especially considering the significant taxes we have to pay. Taxes are like the inevitable bills on our financial journey, but here is the key insight – mastering tax efficiency can help you save even more.
Today’s article will dive into why tax efficiency is crucial. Explore smart investment strategies to reduce your tax burden, and understand how to plan your taxes cleverly.
Let’s get started.
Why Mastering Tax Efficiency is Essential?
Mastering tax efficiency is like applying the age-old wisdom of ‘A stitch in time saves nine’ to your financial journey. While planning your wealth creation journey, every bit of tax efficiency you achieve saves a substantial portion of your hard-earned money.
The beauty of tax efficiency is that it doesn’t just lower your current tax bill; it also turbocharges your wealth accumulation. It lets your money work more effectively for you, helping you achieve your financial goals faster. So, in essence, it is a win-win strategy for your finances.
How to Gain Maximum Tax Efficiency?
When it comes to saving taxes, the age-old saying, ‘Slow and steady wins the race’, cannot be more appropriate.
Long-term investments typically have lower tax implications, which is a major advantage.
You see, the capital gains you have to pay on investments held for more than one year are considered long-term, and these enjoy a lower tax rate. However, it’s essential to note that this
applies primarily to stocks. For bonds, long-term capital gains are applicable only if the bond is held for over three years.
Here is how holding shares for the long term can help you save on taxes:
Long-Term Capital Gains (LTCG)
If you hold shares or equity-oriented mutual funds for over a year, and your gains exceed Rs 1 lakh within a fiscal year, you are subject to a tax of 10%. For example, if you invested Rs 2 lakh in a set of stocks five years ago, and they are now worth Rs 4 lakh, selling them would result in capital gains of Rs 2 lakh. Since you have held these assets for more than a year, your gains qualify as LTCG. In this case, your tax liability would be 10% on the Rs 1 lakh that exceeds the Rs 1 lakh threshold. So, you would pay Rs 10,000 in taxes on your gains.
Short-Term Capital Gains (STCG)
If you sell your shares or equity-oriented mutual funds within a year of acquiring them, you are subjected to Short-Term Capital Gains (STCG) tax. This is taxed at a rate of 15%, plus surcharge and cess if applicable.
For instance, if you invested Rs 2 lakh in stocks and sold them within six months for Rs 2.2 lakh, this would be considered STCG. You would pay a 15% tax on the Rs 20,000 profit, amounting to Rs 3,000.
As you can see, short-term gains are taxed at a higher rate compared to long-term gains.
This is why the ‘slow and steady’ approach of long-term investing is not just about potential wealth accumulation. It is also about optimising your tax situation. By holding onto your investments for extended periods, you not only give your investments more time to grow but also ensure that when you do realise your gains, they are taxed at a significantly lower rate. This ultimately helps you save more money.
Investing in Tax-Efficient Assets
Investing in tax-efficient assets is a great strategy to reduce your tax burden. Consider tax-saving instruments like the Public Provident Fund (PPF), National Pension Scheme (NPS), Sukanya Samriddhi Yojana (if you have a girl child), and Post Office schemes. All of these offer tax deductions under Section 80C, up to Rs 1.5 lakh per annum.
If you prefer not to lock your money away for years but still want to invest in mutual funds, consider Equity-Linked Saving Schemes (ELSS).
Tax Harvesting Strategy
Tax harvesting strategies are similar to the age-old saying, ‘Make hay while the sun shines’, meaning you make the most of a favourable situation while it lasts.
Tax Profit Harvesting
This strategy involves strategically booking long-term capital gains to take advantage of tax exemptions.
Here is an example:
Imagine you have invested in shares of Company ABC with an initial amount of Rs 8,00,000. Your goal is to sell these shares for Rs 10,00,000 after two years. In the first year, your financial instincts prove right, and you make a profit of Rs 80,000.
In this scenario, you decide to book profits of Rs 80,000. With this gain of Rs 80,000, you qualify for an exemption on Long-Term Capital Gains (LTCG). So, you pay no tax on this profit! After a few days, you can reinvest your capital by purchasing shares of the same company once again.
Tax Loss Harvesting
Now, let’s consider the flip side. Suppose you have invested in two different companies:
- In ABC Ltd you made a profit of Rs 50,000.
- In XYZ Ltd, unfortunately, you made a loss of Rs 30,000.
Despite the loss in XYZ Ltd, you have a strong belief in the company. However, for tax purposes, you apply a simple trick.
You have made a profit in ABC Ltd (Rs 50,000), where you have to pay a Short-Term Capital Gains (STCG) tax at a rate of 15%, which amounts to Rs 7,500.
For your loss in XYZ Ltd (Rs 30,000), you have a choice. You can choose to book the loss to reduce your tax liability or hold onto the shares with the hope that they will be appreciated in the long run.
If you decide to book the loss, you can offset it against his profits in ABC Ltd. This means your taxable gains from ABC Ltd (Rs 50,000) will now be reduced by the loss from XYZ Ltd (Rs 30,000), resulting in taxable gains of Rs 20,000.
When managing your taxes, always take deductions and exemptions seriously. They can significantly reduce your tax burden. Here are a few important points to consider:
Section 10 Exemptions
Specific incomes, like House Rent Allowance (HRA) and Leave Travel Allowance (LTA), are eligible for exemptions under Section 10. Leveraging these exemptions can substantially lower your tax liability.
Home Loan Interest
If you have taken a home loan to make your dream of homeownership a reality, remember that the interest paid on the home loan is eligible for deductions under Section 24(B). This makes owning a home affordable and reduces your taxable income.
Health Insurance Premiums
Your health is your most valuable asset. Under Section 80D, you can claim deductions on health insurance premiums for yourself, your family, and your parents. This often-overlooked deduction saves you money and ensures your well-being is protected.
Donations to approved charitable organisations qualify for deductions under Section 80G. By contributing to a cause you care about, you can reduce your tax liability while positively impacting the world.
In conclusion, just as the saying goes, ‘Boond boond se sagar banta hai’ (Every drop contributes to the ocean), taking small steps to master tax efficiency can lead to substantial wealth accumulation over time. Recognising the significance of tax efficiency, embracing tax-efficient investment practices, and making smart tax planning decisions are the cornerstones of financial prosperity.
So, take charge of your financial future and let your money work smarter for you.
*The article is for information purposes only. This is not an investment advice.