Earning a salary? Save tax the smart way!

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:

• Do you need a house? Does your employer offer Rent Free Accommodation or House Rent Allowance? Then go for it, as the amount gets deducted from your total taxable income.
  
• Does your company expect you to wear uniform at work? If so, the expenses incurred on buying and maintenance the uniform will not be taxed.
  
• Does your employer provide you with allowance for your children's education and hostel accommodation? Then use it to claim exemption under section 10 (14).
  
• Does your company provide you with a telephone facility in your home? Then it not taxed. However be warned against taking telephone allowance, since it is totally taxable and will increase your taxable income.
  
• Opt for the car facility, since the value of the perk is much lower than the actual expenditure incurred on the car.
  
• We all have to visit the doctor at some point of time. So save tax by claiming medical reimbursements up to Rs 15,000.00 p.a. But don't take any medical allowance, since it is completely taxable.
  
• If your employer pays Fringe Benefit tax (FBT), then sum of fringe benefits, is tax-free for you. Also if salary is paid in arrears or in advance, claim relief under section 89 (1).
  
• Always ask your employer to include dearness allowance and dearness pay along with commissions earned in your salary. It will lower your tax liability on house rent allowance, gratuity and pension.
  
• If you are eligible for a pension, always get it commuted, as commuted pension is tax-free for government employees and partially exempted for others. You can get tax relief under section 89(1).
  
• If your current employer is participating in an authorized provident fund, and you change your employer within 5 years of joining the firm, ensure your new employer is also a member of the authorized provident firm. It will let you transfer the corpus in your provident fund to the new company without paying any tax. Also insist your employer fix his contribution to your provident fund to 12% of your salary, as it is the highest limit for tax exemption.
  
• Plan your retirement or resignation at the start of the financial year in order to lower the tax on retirement benefits.
  
• As leave travel concession is not taxed if certain criteria are fulfilled, try to claim this incentive to the highest possible level, without having to pay any tax.

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.

• Insurance: All payments made towards both life and health insurance are eligible for tax benefits. Even contributions made towards pension payments can be eligible for tax benefits. Health insurance can let you save Rs. 15,000 over and above the ceiling of Rs. 1 lakh.
• PPF: It is one of the safest tax saving investments available. Both interest and capital withdrawal from the fund are tax free. However its drawback is the lock-in period of 15 years.
• NSC, Post office (CTD) accounts: These are government savings schemes available at post office, with a lock-in period of 5 years.
• Bank deposits: These are special tax saving FDs offered by banks with a lock-in period of 5 years.
• ELSS: These are tax savings instruments offered by mutual funds, with a lock-in period of 3 years. They invest in various quality stocks.

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:

• Housing loan and education loan
• Donation to charities/religious trusts

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.