Investment Shastra

A child brings Joy, Responsibilities & Tax Benefits!

All of us love children. Well, most of us do. But no one can contest the fact that expenses of raising children, their education and marriage are rising with each passing day. These expenses form a substantial outflow from one’s income. But are you aware that certain expenses or investments made in your child’s name can save you taxes?

In the previous blog, we discussed how a newlywed couple can benefit from tax planning. Now, we go a step ahead in explaining how a couple with children, who are either minor (below 18 years of age) or adult (above 18 years of age), can benefit from tax planning.

In this article, we have considered two scenarios:

  •  Couple having minor child
  •  Couple having adult child

Scenario 1:

Ramesh, a 38 years old engineer in Pune, has a 8 years old child. His annual income is 15 lakhs p.a. and his annual tax liability comes out to be Rs. 2,88,400. Let’s see how thoughtful investments aiming at tax benefits can secure his family life.

Now, considering the dependency factor that has increased here with the addition of child, suggested allocation in equity linked instruments would be ~40-50% and preferably in NPS. To meet a medium term financial goal in coming 10-15 years, ~15-25% can be invested in PPF and ~10% in FD to meet  financial goals, let’s say, in next 5 years.

As the child is minor, he does not bring a separate tax file. Thus, any income or gift received by the child should be clubbed with Ramesh’s earnings. Let’s say, the amount invested in the Ramesh’s Child’s name generates an income of Rs. 1,300 p.a. Income up to Rs. 1,500 p.a per minor child is exempt and thus, not included in the parent’s income.  Hence, the investment income of Rs. 1,300 generated during the year will not be included in Ramesh’s income.

Ramesh can also claim education allowance, which allows deduction of Rs. 100 per month per child with a maximum of 2 kids. If he plans to put his child in boarding school, he can claim a deduction of Rs. 300 per month as child’s hostel allowance.

Specific beneficiary Trust:

However, if Ramesh  does not want to club the income of  his minor child with his own income, a separate independent 100% ‘specific beneficiary trust’ in the name of the child can be created, by drafting the terms and conditions in trust deed. While drafting trust deed, it is to be clearly mentioned that as long as the child is minor, during that time, no part of the trust income is to be spent on child, which will ensure no clubbing of minor’s trust income with the parent’s income. Gifts or investments in FD’s and other taxable instruments should be done through this trust only, to avoid the income clubbing.

With minor kids, HUF formation is not considered as it turns out to be a too costly and complex affair; the reasons already mentioned in the previous blog.

Scenario 2:

Suresh, a 46 years old General Manager has two children aged 19 & 13 years, respectively. His salaried income is Rs. 22 lakhs annually and receives Rs. 4,00,000 p.a. as rent from ancestral property. His elder child is planning to study abroad.

His tax liability comes out to be Rs. 6,28,300 p.a. Let’s see how efficient tax planning comes to his rescue. In this case, dependency factor has not changed much, thus, suggested allocation in equity linked instruments would be ~35-45% and preferably in NPS. To meet a medium term financial goal in coming 10-15 years, ~15-25% can be invested in PPF and ~10% in FD to meet  financial goals, let’s say in next, 5 years.

Coming to his elder Childs’ plans for overseas studies, Suresh can take an education loan to fund his son’s higher studies. This would attract repayment burden, but the entire amount of interest paid towards the education loan can be claimed as a deduction.

As his son is an adult now, a separate PPF account should be opened in his name. His son can deposit up to a maximum amount of Rs. 1,00,000 separately.

Also, any gifts which Suresh’s children receive will not attract gift tax, which, if invested properly, can go a long way in preparing a good corpus for the children.

Suresh receives Rs. 4 lakhs as income from house property, which calls for tax of Rs. 1.2 lakhs @ 30%. However, if he forms an HUF (Hindu Undivided Family) where he acts as karta and his wife as member and children as co-parceners, his tax liability gets reduced. For opening an HUF, PAN card in the name of the HUF and a separate bank account is required. The HUF is a separate entity in itself and qualifies for all tax benefits under section 80C, 80D, 80G etc. Tax slab applicable to HUF is similar to that of an individual taxpayer.

His tax liability with and without HUF would be:

Tax Calculation

Thus, with the formation of an HUF, his tax liability gets reduced to Rs. 4,07,580 (4,02,730 + 4,850) against the tax liability of Rs. 5,26,330 without HUF, giving him the benefit of Rs. 1,18,750.

Again, these are just a few pointers and not an exhaustive list, which would come handy for parents with kids in not only reducing tax but also ensuring a safe and secure future for all of them.

In the next article, we will focus on the best tax planning approach post-retirement.

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Anupama Shukla - Team MoneyWorks4me