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Income tax for dummies: If you are a young, salaried individual

In this world nothing can be said to be certain, except death and taxes. — Benjamin Franklin

You must remember the day you got your first paycheck. I literally felt like a king on my first payday. A bank account filled with money that I could finally call my own. Nothing can match this high.

But sadly, not everything we earn belongs to us.

No, I am not talking about our families here. I am talking about the government.

The day you start earning, government will try to tax you. So with just 3 months before current financial year ends, I am sure you would be frequently hearing the phrase ‘tax saving’ from your more experienced colleagues.

No one likes to pay taxes. But we need to. So keeping aside your likes/dislikes, let’s discuss some frequently asked question (FAQs) most young professionals have in their mind.

Question: Does my income attract tax?

Answer: The answer is simple. If your taxable income is less than ₹2.5 lakh, you don’t need to pay any taxes. Cheers!

But if your taxable income is more than ₹2.5 lakh, then you need to pay taxes as following:

  • Slab 1: 10% on income between ₹2.5 lakh and ₹5 lakh
  • Slab 2: ₹25,000 + 20% of income between ₹5 lakh and ₹10 lakh
  • Slab 3: ₹1,25,000 + 30% of income above ₹10 lakh

Let’s take an example. If your monthly salary is ₹50,000, then your annual taxable income is ₹6 lakh.

This means you need to pay ₹45,000 as tax – calculated as follows:

= ₹25,000 + 20% of (₹6 lakh – ₹5 lakh)
= ₹25,000 + ₹20,000
= ₹45,000 (excluding education cess, etc.)

I am sure you would want to reduce your taxes to bare minimum. Isn’t it? Interestingly, there are ways to do that.

Question: What is Section 80C of the Income Tax Act?

Answer: Section 80C of the Income Tax Act deals specifically with tax-saving options. The total savings limit under this Section is ₹1.5 lakh. All your contributions towards small savings and investment schemes like Employee Provident Fund (EPF), Public Provident Fund (PPF), National Savings Certificate (NSC), Equity-Linked Savings Scheme (ELSS), etc. and premium payments for buying life insurance are eligible for deduction under Section 80C.

You will be surprised to know that if you use Section 80C intelligently, you can save almost ₹45,000 (before cess) in taxes if you belong to the highest tax slab (of 30%) and utilise the full ₹1.5 lakh limit.

Question: Should I open a PPF account?

Answer: PPF is a government guaranteed savings scheme (offering 8.7%) where your contributions are eligible for tax deduction. It is one of the safest investment options for your money. The best part about PPF is its EEE nature (i.e. Exempt, Exempt, Exempt). So not only is your contribution exempted, but also the interest earned and withdrawals.

Also as you have just started earning, you have the benefit of age on your side and your savings get a longer time to compound. So PPF is one good option that you should seriously consider.

Problem with a guaranteed-return product such as PPF is that it fails to compete with other asset classes that offer potentially higher rates of return.

As many of you might have guesses, I am talking about equity and equity linked products.

Question: Should I invest in ELSS?

Answer: Investments in ELSS also count towards Section 80C and hence, are eligible for tax benefits. ELSS has the potential to give long-term inflation-beating returns of 14% to 16% but can be volatile in short term. Also, an ELSS has the lowest lock-in period (3 years) among all 80C investments.

You might have observed that in long term, average returns given by equity MFs (like ELSS) beat safer options like PPF. But that doesn’t mean that you should put all your money in equity MFs. A balanced approach is advisable, where you diversify your investments across different asset classes to reduce the risk of overconcentration.

Question: I had taken an education loan. How will it benefit me?

Answer: In case if you have taken an education loan to fund your studies, then you can get tax benefits during repayment period. The interest paid (not principal) can be claimed as deduction while calculating your taxable income.

The best part is that there is no upper limit for deduction in respect to interest on this loan and you can claim these deduction over and above your deductions under Section 80C. So here is education paying you back with tax savings as well.

Question: How do I file my returns?

Answer: Once you are done with your calculations and tax savings, time comes to actually file your returns.

Technology has made it very easy to do so and you can simply log into Income Tax department’s website to file your taxes. If you don’t want to do it on your own, then you can avail services of any Chartered Accountant (CA) or any of the newly launched startups that offer such services online.

Note – If you already contribute towards EPF, then you can reduce your PPF contributions and increase ELSS contributions.

You may also like to read: Planning taxes when nearing retirement

Disclaimer – Every individual’s financial needs and risk appetite are unique. Hence while deciding a tax-saving strategy, one needs to consider individual requirements. Above discussion should be treated as a general treatment of the topic of tax-saving.

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