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Earning a salary? Save tax the smart way!

February 11, 2010 16:10 IST

Earning a salary? Looking to save tax the smart way? Then you have two options. First is salary restructuring and second is tax saving instruments. Here we take a look at both these options and how to use them effectively.

Salary restructuring: As the term implies, salary restructuring allows you to redesign your salary, so as to reduce your total tax liability. Here are some steps you can take in order to reduce your tax liability:

Let us assume your annual salary is Rs 200,000. You get HRA of Rs 10,000 and your medical reimbursement is Rs 5,000. Your employer gives you an allowance of Rs 15,000 for your son's educational expenses. So instead of Rs 200,000 your total taxable salary now becomes Rs 170,000 (2,00,000 - 10,000 - 5,000 - 15,000). This will effectively reduce your tax liability.

Now that we have seen how to design your salary let us take a look at the most effective tax saving instruments available.

Tax saving instruments: While these instruments do help you save tax, they have a maximum limit of Rs 100,000. Any income above this limit attracts tax.

All these instruments carry different degrees of risks. While PPF, NSC, Post office accounts, insurance (except ULIPs) and FDs are safer, they offer lower returns and are not very liquid, due to their long lock-in period.

On the other hand, ELSS has a short lock-in period but is more risky, while ULIPs carry the risk of ELSS but without the liquidity benefit. So while investing for tax saving purpose, take into account factors like your risk appetite, returns generated by the instrument, liquidity, capital appreciation and safety of capital.

Remember, if you are young, riskier options are better for you, since over a long time, these instruments can generate higher returns for you, and minimize the risk of capital erosion. Also diversify your investment portfolio.

If these options are not enough for you, then here are some more:

To summarize, first thing to do is to structure your salary so as to minimize your tax liability. This will minimize the need to invest for tax saving. This is because as with any investment, you must have the necessary capital to invest.

Also the instruments that tend to be safer, have a longer lock-in period with low returns. This means you must keep on investing with fresh capital every year and in turn get meager returns.

Those investments with higher returns mean you may not be able to withdraw your money even after the lock-in period, if the value of your investment is lesser than the capital invested. Take all these points into consideration before opting for tax saving plans.

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