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How to do effective tax and estate planning

By Ranjeet S Mudholkar

With the growth of financial planning, people have started considering several aspects of personal finance important, which were not given much importance hitherto. One such is estate planning. Just the way it is important to create wealth, it is equally important to secure its transition to our loved ones without any legal hassles after we are gone. This, along with the ever felt need for optimisation of tax liability, highlights the importance of effective tax and estate planning.

Need for estate planning

The primary purpose of estate planning is to protect, preserve and manage the assets. Timely succession and estate planning is a key to hassle-free future for one and family. A survey in the US regarding wills and estate planning found that only 44 percent of the respondents have any document related to estate planning. In India, the level is still lower.

 How to do effective tax and estate planning

It must be kept in mind that tax planning should not be seen in isolation. Reuters

Need for tax planning

Tax forms the part of expenses in an individual's monthly budget in the category of indiscretionary expenditure. There are two types of taxes an individual is exposed to

a. Direct taxes - personal income tax

b. Indirect taxes- customs duty, excise duty, service tax etc

It must be kept in mind that tax planning should not be seen in isolation; rather it should be a part of a holistic financial plan treating tax as expenditure. The expenditure on taxes need to be minimised. While there are many provisions in the Indian Income Tax Act, 1961 which allows an individual to optimise tax liability, indirect taxes may be optimised by innovative strategies like MRP reduction to reduce the incidence of the tax. Required items such as laptops, cameras and televisions can be bought for personal use even if one is travelling abroad on business purpose. However, it is important to ensure that net income of an individual should be divided into three equal parts to be used for current expenses, debt repayment and investment for the future.

Listed below are the sections under which an individual may claim deductions from taxable income.

Section 80C: It provides the list of various financial instruments which one could make to claim a deduction from taxable income to a limit of Rs 1 lakh. The instruments range from life insurance policies, fixed deposits in banks to equity linked savings schemes (elss) of mutual funds.

Section 24: Under this section the deduction is given on the interest on the housing loan up to a limit of Rs 150,000 for a self occupied property. There is no limit for this deduction if the property is let out on rent. Thus buying a second house becomes an attractive proposition for tax efficiency in addition to being a potential high yield investment.

Section 54, 54b, 54 EC, 54G, 54F, 54GA: Under these sections, exemptions are given in case of long term capital gains either if one invests the proceeds in acquiring another housing property or invests the capital gains in various specified instruments.

In addition to the sections mentioned above, there is no long-term capital gains tax on listed equity shares and units of equity oriented mutual funds. Short-term capital gains tax in this case is charged at a lower rate of 15 percent.

Estate planning: importance

The table below gives the distribution of wealth amongst different asset classes as on March 31 2010.

Chart06MayIn addition to the above categories, there is a sizeable amount dedicated to real estate and precious metals, including gold jewellery which needs to be accounted for transfer to legal heirs. Thus it can be clearly seen that there is a huge amount of individual wealth which needs to be provided for the distribution through estate planning in our country.

Tools of estate planning

To put simply, estate planning is the legal arrangement for the transfer and distribution of one's wealth in anticipation of death and the process by which the arrangement is completed. Estate planning involves the bequeathing arrangement through either a will or trust.

Mentioned below are the modes through which estate planning may be incorporated as part of a well documented financial plan and ensure that the wealth is distributed as per the desire of the individual.

Will

The term will is defined under "Section 2(h) of The "Indian Succession Act, 1925" and means the legal declaration of the intention of the testator with respect to his property which he desires to be carried into effect after his death. A will or testament is a legal declaration by which a person, the testator, names one or more persons to manage his estate and provides for the transfer of his property at death. A will may be written on a plane piece of paper by a person of sound mind is legally admissible.

Proper execution involves the step that the maker signs, dates and acknowledges the will in the presence of two legally competent adult witnesses one of whom may be a notary public and second one preferably a doctor and both are not beneficiaries of the will. A point to note here is that a "nominee" is a person who is designated to act on the behalf of the other, while a beneficiary is the person who is eligible to receive the benefits under the will. The nominee may receive the inheritance for the use of beneficiary.

Power of attorney

Power of Attorney (POA) is a legal arrangement which authorises other person to act on one's behalf. There are two types of power of attorneys:

a) Financial power of attorney: It decides who will manage the money.

b) Medical power of attorney: It decides who will take health care decisions, if one is not able to take them himself/herself.

Trust

A trust is used in place of will to transfer the ownership of financial assets where direct or immediate transfer is not possible due to certain reasons and the purpose is to protect the interests of the beneficiaries. A trust is a legal relationship where property (real or personal, tangible or intangible) is held by one party for the benefit of another and it conventionally arises when property is transferred by one party to be held by another party for the benefit of a third party. It is also possible for a legal owner to create a trust of property without transferring it to anyone else, simply by declaring that the property will henceforth be held for the benefit of the beneficiary.

Gifts

Gift is also a mode thorough which the wealth can be transferred to the legal heirs or the intended person, the only difference being that the person will have to give the gift during his lifetime. Gift being received is exempted from tax to the limit of Rs 50,000 under the provisions of Income Tax Act, 1961. However, gift received from relatives at the time of wedding is exempt from tax.

In case of a Hindu undivided family (HUF), the share of the father can be transferred to the eldest son, who shall be Karta, either by will or as per Hindu Succession Act, 1956 in case of interstate succession Class I heirs shall be entitled to the share of father if he is a co parcener.

Conclusion

Thus it can be clearly seen that tax and estate planning are integral parts of the financial planning process which carves a security cover around the wealth and assets already created for entitling them to dependents without any legal hassles with optimum tax efficiency. Though the process is challenging both emotionally and technically, taking the services of a certified financial planner, or CFP, is preferable who can guide one through the process getting the right inputs as and when required.

The writer is working with Financial Planning Standards Board India (FPSB India) in the capacity of Vice Chairman and Chief Executive Officer. The views expressed here are personal, and do not necessarily represent that of the organization.

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Updated Date: Dec 21, 2014 02:19:47 IST