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    FAMILY PROTECTION

    Tax optimization to reduce your tax outgo by 28%

    Last Updated On 19-02-2020

    The Income Tax Act, 1961, contains many provisions that can be used for tax optimization. By knowing which provisions of the Act can help you obtain some tax relief, you can lower the burden of tax on your income significantly. There are several tax-saving investment options available in the financial market, and by choosing the right options, you can achieve the right level of tax optimization.

    Among these investment options, tax-saving fixed deposits, NPS, mutual funds, and ULIPs are quite commonly preferred. Term insurance plans and life insurance policies are also excellent investment options for tax optimization. You can learn more about Life Insurance , Retirement Plan by browsing the website for the various Term Plans offered by PNB MetLife.

    National Pension Scheme (NPS), in particular, can help the average taxpayer save as much as 28% on taxes. To understand these metrics better, let’s take a look at the case of Sudeep, a salaried private-sector employee who earns around 17 lakhs per annum. Here are the details of his earnings.

     

    Particulars

    Current Figures (in rupees)

    1

    Basic salary

    10,80,160

    2

    Dearness allowance (at 10% of the basic salary)

    1,08,016

    3

    Medical allowance

    3,00,000

    4

    Entertainment allowance

    2,13,920

    5

    Total income under the head salaries (A)
    (sum of 1 to 4)

    17,02,096

    6

    Investment in provident fund

    80,000

    7

    Premium paid for life insurance

    50,000

    8

    Investment in NPS

    30,000

    9

    Total tax-saving investments (sum of 6 to 8)

    1,60,000

    10

    Total 80C deductions permissible (B)
    (lower of Rs. 1,50,000 or the amount in row 9)

    1,50,000

    11

    Total taxable income (A - B)

    15,52,096

    12

    Tax thereon

    2,78,129

    As you can see from the details of Sudeep’s income, he has managed to maximize the deduction limit under section 80C. Nevertheless, his tax liability is greater than the basic salary he earns over the course of 3 months. In this case, a bit of tax optimization may be able to help Sudeep reduce the burden of tax liability.

    Here’s a quick look at some ways in which he can save more tax.

    Step 1: Reconstituting the salary structure
    Currently, Sudeep’s salary includes 3 allowances (dearness, medical, and entertainment allowance), all of which are fully taxable. By rearranging the structure to include more tax-free perquisites and fewer fully taxable allowances, Sudeep’s income from salary can be reduced quite a bit.

    For instance, leave travel allowance (LTA) is a perquisite that can help bring down the taxable component of his salary income. By using the LTA for funding his travel expenses and by submitting the necessary bills, Sudeep can claim the whole of the leave travel allowance (or the cost of travel, if its lower), as a deduction.

    Step 2: Taking advantage of section 80CCD(2)
    Here’s where investing in the National Pension Scheme can help Sudeep. This section of the Income Tax Act provides that the employer’s contribution to NPS is eligible for deduction up to 10% of the basic salary. By asking his employer to eliminate his dearness allowance and make a contribution to NPS instead, Sudeep can enjoy more tax savings.

    Step 3: Make use of the provision of section 80CCD(1B)
    This section allows the taxpayer to claim an additional deduction of Rs. 50,000 for investing in the National Pension Scheme. The great news is that this tax benefit is over and above the 1.5-lakh-limit proposed by section 80C. So, by investing an additional Rs. 50,000 in NPS, Sudeep can bring down his tax liability even further.

    Step 4: Invest in health insurance
    Section 80D allows for a maximum deduction of Rs. 25,000 on the premiums paid for purchasing health insurance for yourself, your spouse, and your kids. Even if Sudeep only opts for a policy that charges Rs. 20,000 as premium per year, he can enjoy a significant reduction in his tax burden. 

    Once he’s followed the above-mentioned steps for tax optimization, his tax liability can go down by as much as 28%

    Here’s a better look at his income structure after these changes.

     

    Particulars

    Current Figures
    (in rupees)

    After tax optimization
    (in rupees)

    Comments

    1

    Basic salary

    10,80,160

    10,80,160

    Remains unchanged

    2

    Dearness allowance (at 10% of the basic salary)

    1,08,016

    Nil

    Fully taxable allowance removed

    3

    Medical allowance

    3,00,000

    2,60,000

    Fully taxable allowance reduced

    4

    Entertainment allowance

    2,13,920

    1,73,920

    Fully taxable allowance reduced

    5

    Leave travel allowance

    Nil

    80,000

    Tax-free allowance added

    6

    Employer's contribution to NPS u/s 80CCD(2)

    Nil

    1,08,016

    10% of basic salary

    7

    Total income under the head salaries (A)
    (sum of 1 to 6)

    17,02,096

    17,02,096

    Salary remains unchanged overall. It has only been reconstituted to make room for more tax-free benefits.

    8

    Investment in provident fund

    80,000

    80,000

    Remains unchanged

    9

    Premium paid for life insurance

    50,000

    50,000

    Remains unchanged

    10

    Investment in NPS

    30,000

    30,000

    Remains unchanged

    11

    Total tax-saving investments
    (sum of 8 to 10)

    1,60,000

    1,60,000

     

    12

    Total 80C deductions permissible (B)
    (lower of Rs. 1,50,000 or the amount in row 11)

    1,50,000

    1,50,000

     

    13

    Investment in NPS u/s 80CCD(1B)

    Nil

    50,000

    Additional investment in NPS

    14

    Investment in medical/health insurance u/s 80D

    Nil

    20,000

    Additional investment in health insurance

    15

    LTA deductible

    Nil

    80,000

    This is deductible if Sudeep uses the LTA and produces the required bills

    16

    Deductions u/s 80CCD(2)

    Nil

    1,08,016

    Employer's contribution to NPS

    17

    Total additional deductions after tax optimization (C)
    (sum of row 13 to 16)

    Nil

    2,58,016

    Tax optimization as per the steps detailed above.

    18

    Total taxable income (A – B - C)

    15,52,096

    12,94,080

     

    19

    Tax thereon

    2,78,129

    2,00,724

    This reduces tax by Rs. 77,405 (or 28%)

    By following these tax optimization strategies, Sudeep can successfully reduce his taxes by around Rs. 77,000. This is nearly 28% of his tax liability prior to optimization. 

    The takeaway
    When you earn a well-deserved hike in your salary, it may push you into the highest income tax slab, resulting in increased tax liabilities. At first glance, it may appear that there’s no relief from the steep tax rates charged on your income. However, with a little bit of research, you can bring down your tax burden significantly. Investment options like term insurance and NPS can prove to be particularly useful.


    Sources:
    [1] https://www.bemoneyaware.com/blog/nps-tax-benefits-and-sections-80ccd1-80ccd2-and-80ccd1b/
    [2] https://www.apnaplan.com/tax-free-salary-components/
    [3] https://www.paisabazaar.com/tax/taxable-benefits/

    • *Tax benefits are subject to conditions and other provisions of the Indian tax laws and are subject to amendments made thereto from time to time.

    Disclaimer:

    The aforesaid article presents the view of an independent writer who is an expert on financial and insurance matters. PNB MetLife India Insurance Co. Ltd. doesn’t influence or support views of the writer of the article in any way. The article is informative in nature and PNB MetLife and/ or the writer of the article shall not be responsible for any direct/ indirect loss or liability or medical complications incurred by the reader for taking any decisions based on the contents and information given in article. Please consult your financial advisor/ insurance advisor/ health advisor before making any decision.

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