The 3-I principle for an effective Financial planning by a salaried Individual

In the developing economy like India, the class which is impacted financially the most due to any slightest change in the economic climate nationally or globally is none other than the middle class that too the salaried segment. The reasons are many but one among them is theirambitious approach for a quick change in their lifestyle andfinancial status. They always struggle for a better prospects for their wards.A proper financial planning in place would maketheir dreams come true despiteadversity. It is the 3-I principle – the Three “I” are INFLATION -INCOME TAX -INSURANCE.  This Article describes how todeal with these parameters.

The first I namely Inflation – means increase in the prices of various commodities over a period of time. It is quite surprising for many and shocking for a few thatdespiteanincrease in theirsalary, how come there is no increase in their savings. There are TWO reasons for this – the first reason being that the increase in income may not be sufficient to hedge against the inflation rate – andthe second being that he is spending more than he required, thinking that he deserves better lifestyle things as his earnings have increased.Whatever may be the reason- the inflation leads to less savings for future and ultimately leads to poor financial situation in future.

To curtail this tendency, one has to chalk out the details of his spendings-category-wise like rent, groceries, Petrol expenses for daily travel, weekendeating out, holiday travelling, etc. After this one has to check out the inflation on each category. This exercise would tell where to cut the expenses or postpone them for the time-being.This will help to maintain the same level of savings/Investments despite an increase in the inflation in the economy.One has to prepare to set aside at least 25% of his income towards his future financial goals. Once this becomes a habit, the inflation does not bother much and the increase in the income due to salary-hike automaticallyincreases thesavings for the future financial needs like children education/marriage or leading a happy retired life.

The second “I” represents how to use the relevant Income Tax provisions for better financial planning. For this he should know various Income Tax Provisionsapplicable to the salaried class to reduce the tax liabilities.

The present tax rates as per the old regime is as follows:

The TAX rates (old Regime)

Surcharge is payable Extra on Income Tax

Income Exceeding Rs 50 lakhs up to Rs 1Cr – 10%

Income Exceeding Rs 1Cr and up to Rs 2Cr – 15%

Income Exceeding Rs 2Cr and up to Rs 5Cr – 25%

Income Exceeding Rs 5Cr and beyond – 37%

Health & Education Cess Extra 4% on Income Tax and Surcharge

 One should also know how to choose the right investment tool to reduce the tax burden. If he acquires expertise in this, he can use various statutory exemptions to save tax and divert that amount to future savings.

The IncomeTax Act consists of various sections which provide statutory exemptions that help in saving the TAX payable to Government. These savings can be diverted for future savings as a part of financial planning. The relevant sections of the Income tax act applicable to the salaried people are appended below:

Section 80 (C) -expenses and investments up to maximum 1,50,000/-in a financial year.

Section 80 (D)-Medical insurance premium and expenses up to maximum 75000/- (Self, family and senior citizen parents)

Section 80 (DD)-Medical, Nursing and Rehabilitation expenses on dependent handicapped (75 k to 1.25 L depending on 40%-80% disability)

Section 80 (E)-Interest on Education Loan for spouse and children – no cap – total interest is exempted.

Section 80 (G)- donations to CharitableOrganizations -no cap-Total donation is exempted.

Section 80 (GGC)-Donations to Political parties- maximum is -10% of gross Income

Section 80 (TTA)- interest income earned up to maximum 10 K

Section 24 (B)-interest exemption on home loanup to maximum 2 L for self-occupied and no cap for let-out property.

Section 80 (CCC)-Deduction on any payment made in the previous year to keep in force a contract for annuity plan of LIC or any other insurer- Deduction Limit – Rs 1.50 lakh

Section 80 (CCD-1B)-An additional amount of Rs 50,000 paid towards notified pension schemes of government is allowed over and above 80(C) limit of Rs.1.5 lakh

Now we examine a case to understand to what extent we can save on tax by applying the above sections.

Case : Mr. Savings Rao-aged 30 years, has an assessable income of 20 Lakhs.  As per the old Tax regime he falls under 30% slab .

Let us workout how much taxcan hesaveif he knows various sections of Income Tax Act:

Tax liability (including edu cess) on 1,50,000 = 150000X30%x104%=46800/-

Had he saved/invested this amount of 150,000 in any of the following Financial instruments he could have saved this 46800/- every year !!

 Mr.Savings Raocould invest this amount in any interest/dividend giving instrument every year till he retires  i(ie) for 30 years – doesn’t it accumulates into a HUGE CORPUS ?

U/S 80C: (he can invest in any one of the following  financial instruments)

Contribution to Provident Fund-150,000 X 30%=45,000X104%=           46800/-

Contribution to Provident Fund                                                             46800/-

Payment of life insurance premiums                                                    46800/-

Investment in ELSS mutual funds                                                           46800/-

Repayment of housing loan                                                                       46800/-

Tuition fees for children’s education                                                       46800/-

Investment in fixed deposit with banks and post offices(5years)      46800/-

National Savings Certificate                                                                       46800/-

He can further invest 15600/- if he contributes to NPS as below:

U/S 80 CCD(1b)

ContributiontoNationalPensionSystem=50,000X30%=15000X104%=15600/-

If Mr.Savings Rao invest above mentioned saved amount in Banks/post office savings instruments, upto 10k interest amount he does not require to pay tax as such the saved amount is

U/S 80TTA

Savingsinterest =10000X30%=3000X104%                          =     3120/-

However the interest earned over and above 10k would be taxed at the appropriate slab of the assessee (for e.g. 30%).

One can plan his finances in such a way that his investment in banks/post offices should be restricted to get an annual interest of 10 k and the balance amount can be invested in Equity mutual funds or Stocks so that the tax payable would be 15% only under STCG (short term capital Gains) tax. instead of saving in bank/post office accounts and paying interest.

The third Iof this principle is Insurance – how to use insurance as a better tool forfinancial planning. Whatever be the amounts one had saved in Inflation planning and Income-tax planning, that can be invested in various life insurance instruments to complete the financial planning for different future financial needs.

Insurance planning involves building a plan of action that provides adequate insurance against FOUR D’s viz., Death, Disease, Disability, and Dependence. This involves creation of an estate with small amounts pooled over a longer period. Hence the Insurance planning should be started early in the life with amounts invested in an appropriate insurance plan as per the risk to be covered – any or all the 4D’s mentioned above.

 Protection against the untimely death is available with TERM plans. In the market, currently there is so much demand for these products thanks to the COVID19 pandemic. The demand has been so high since the year 2020, that all the insurance companies have enhanced the premium rates of their TERM plans by 20% on an average. Many companies have already announced their plans of further increasing of these premium rates in the second part of 2022. This shows the demand for these plans in the market.

Similar trends were also observed in Health insurance sector that provides protection against Diseases through medical support systems. Although the awareness of having a health insurance policy has significantly increased thanks to the COVID pandemic, many people still don’t understand its importance. Today, maintaining a good health is a big challenge as the stress levels, and risk of lifestyle-related diseases are increasing every day. With the rising medical inflation, securing a required health insurance policy must be an integral part of efficient financial planning. Having a comprehensive health insurance policy allows to provide the best medical treatment facilities to the family without worrying about the expenses. Now-a-days health insurance policies are available with life time renewability option – means you can renew your policy till you alive.

This also saves the person from depleting his own savingsin case of sudden sickness of himself or of any of his family members. The premium paid under a health insurance policy is eligible for tax benefit under Section 80D of the  Income Tax Act up to a maximum amount of Rs. 25,000.

If parents of more than 70 years old, an additional tax benefit of RS.50,000/-is available.

Thus, a health insurance plan helps you save on medical expenses and reduces annual tax outgo.

U/S 80 D

Mediclaim for self and family=25000X30%=7500X104%=             7800/-

Mediclaim for parents(senior)=50000X30%=15000X104%=       15600/-U/S 24(b)

Interest on housing loan=2,00,000X30%=60000X104%=        62400/-

These amounts saved from paying income tax can be invested for future financial needs like children education/marriage/ business capital or for buying own house/flat or for retirement planning.

The third D is disability insurance – Disability due to accident or disease may prevent a person from working – business or job – and stops his income.

Disability insurance replaces lost income when an individual is unable to work because of an accident or illness.

Without disability coverage as part of the financial planning, the savings accumulated  for the purpose of child education and retirement , get depleted . The disabled person who was once the breadwinner becomes the dependent.

Life insurance companies are providing different riders to take care of this risk of disability like the income benefit rider due to accidental disability etc.,

The fourth D is dependence:Another risk associated with life is Dependence post retirement .one should retire at some point of time in the life irrespective of his occupation viz., salaried or business owner. Once the regular monthly income stops, the real struggle starts to lead a better post-retirement life…no clue of for how many years!

Retirement planning is an important stage of financial planning that involves finding out the current income sources and future expenditure to enable to build a decent retirement corpus for the retired life. Forthis one need to learn to live on a fixed budget during his earning years to enable to invest in a decent retirement plan. Retirement planning is a long-term process that should start when you are young. This avoids a state of one becoming a liability to his children when he becomes old.

The investment mantra for every salaried person is “save something,Whatever you can, In a systematic way every month over a period of 15 to 20 years. Be disciplined in not stopping this savings. Think twice before buying unwanted things by getting attracted to the on-line sale melas. If one follows this Investment mantra then no Fund manager in the world can match with this strategy in creating a huge corpus for  one’s medium- and long-termfuture financial needs.