Financial planning thumb rules - The Economic Times
Income tax planning and estate planning elements have become a more a more critical part of overall personal financial planning with the enactment of the strategies for your clients, which broadens your relationship. Tax planning is the analysis of a financial situation or plan from a tax perspective with the purpose of ensuring tax efficiency. Proper tax planning not only reduces the tax liability but also helps save tuition fees, principal repayment of home loan, among others.
Kind of tax-saving instrument: All the above tax-saving instruments by nature are medium to long term products - from a three-year lock-in that comes with ELSS to a year lock-in of PPF. Another important factor to consider is the post-tax return of the tax-saving investment. For instance, most fixed and assured returns products such as NSC provide you with Section 80C benefits but the returns, currently 8.
This makes the effective post-tax return equal to 5. Considering the annual inflation of six per cent, the real return is almost zero! Inflation erodes the purchasing power of money, especially over long term.
Making the right choice First, identify a goal, medium or long term. An equity-backed tax-saving instrument would suit long term goals as equities need time to perform.
What makes tax-saving exercise an important financial planning tool - The Economic Times
As wealth keeps accumulating over the long term, try a tax-free investment. Tax Strategies and Life Stages Tax obligations change more broadly as your stage of life changes. Although everyone is different, there is a typical pattern to aging, earning, and taxes, as shown in Figure 6.
Your family structure does not include dependents, so you have few deductions but also low taxable income.
As you progress in your career, you can expect wages, expenses, and dependents to increase. Because those are the kinds of assets encouraged by the government, they not only build wealth but also create tax advantages—the mortgage interest deduction, retirement, or education savings exemption.
In retirement, most people can anticipate a significant decrease in income from wages and a significant increase in reliance on incomes from investments such as interest, dividends, and gains. Some of those assets may be retirement savings accounts, such as an Individual Retirement Account IRA or k that created tax advantages while growing, but will create tax obligations as income is drawn from them.
Generally, you can expect your income to increase during your middle adult life, but that is when many people typically have dependents and deductions such as mortgage interest and job-related expenses to offset increased tax obligations.
As you age, and especially when you retire, you can expect less income and also fewer deductions: The bigger picture is that at the stages of your life when income is increasing, so are your deductions and exemptions, which tend to decrease as your income decreases. Although your incomes change over your lifetime, you tax obligations change proportionally, so they remain relative to your ability to pay.
The tax consequences of such changes should be anticipated and considered as you evaluate choices for financial strategies. Because the tax code is a matter of law it does change, but because it is also a matter of politics, it changes slowly and only after much public discussion. You can usually be aware of any tax code changes far enough in advance to incorporate them into your planning. Tax Strategies and Personal Financial Planning Tax advantages are sometimes created for personal financial strategies as a way of encouraging certain personal goals.
In the United States, as in most developed economies, certain goals such as home ownership, retirement savings, and education and health financing are seen as personal goals that benefit society as well as the individual. In most cases, tax advantages are created to encourage progress toward those goals.
For example, most people can buy a home only if they can use debt financing, which creates added costs. Emergency fund As the name suggests, an emergency can happen anytime and needs immediate action. There could be a setback to one's earning capacity due to a temporary disability or being unemployed for a few months.
A medical emergency may crop up at a time when the settlement claim is taking time, or the ailment itself may have a waiting period. In such cases, one may have to arrange for funds to tide over the situation. Whether it's meeting the household expenses or honouring commitment towards EMIs, certain cash outflows are sacrosanct. An emergency fund is not aimed at meeting your planned goals, but it only acts as a safety net.
Although there's no fixed rule on how much emergency cash one would need, ideally months' household expenses should be one's emergency fund.
Financial planning thumb rules
The amount should help you to combat financial emergencies. Life cover You should ideally have a life cover which is at least 10 times of your annual income. The actual requirement may, however, depend on one's age, goals to be achieved, financial dependents, accumulated wealth, etc.
The most cost-effective way of buying life insurance is through a pure term insurance plan. It is a low premium, high-cover protection plan where the premium goes entirely towards risk coverage, i. Therefore, on surviving the term, one doesn't get anything back as there is no savings portion of the premium. But that should not deter someone from buying a term plan as risk cover through life insurance as it is one of the basic necessities in one's overall financial plan.
How much to save for retirement Most financial planners suggest a retirement corpus target which is about 20 times of one's annual income. Some feel that 30 times can be a better figure as it will take care of inflation. It gives you a reason to work backwards and estimate how much you need to save from today till you retire. Still, this rule may leave you disappointed as it takes income and not expenses into account.
Also, it may work for those whose retirement is years away than those who are retiring soon. House price By keeping three things into consideration, i. If one is buying a home with a down payment of 20 per cent and the rest on a home loan, and also keeping the income-to-EMI ratio in mind, the affordability arrives at about 4. In other words, one is buying a house which costs about five times of his income.
Therefore, when real estate prices go up, affordability becomes a concern, unless income also moves in tandem. Home loan Before lending, the lender finds out the borrower's existing loan commitments. Banks don't lend an amount on which the EMIs will be more than per cent of the monthly take-home pay.