Income Tax and Financial Decisions

December 16, 2018

What gave me the idea to write down this blog post? The recent announcement by Govt. of India that NPS is now EEE. Before going more into my post, let’s understand what actually happened in case of NPS? As per earlier rules, at the age of 60, whatever corpus you were having, below were the rules for utilization of corpus.

  1. Mandatory purchase of ANNUITY from minimum 40% to maximum 100% of corpus. Annuity itself is to be purchased from Life insurers, operating in India. This ANNUITY is fully TAXABLE.
  2. 40% corpus can be withdrawn Tax free.
  3. 20% corpus can be withdrawn but it’s Taxable

The proposed change is not for Point no. 1 and 2 above. Only Point 3 above. Now this 20% withdrawal is also Tax free. So that’s your E-E-E in NPS.

I recently asked to group members of our facebook group – asan ideas for wealth. Barring EPF (along with VPF component), PPF, Sukanya Samridhi Yojna and interest from Tax free bonds, which other investment instrument has unlimited tax-free income? Point to be noted, Bundled insurance policies were not considered as these are not pure investment instrument. The correct answer is None. Till last FY (2017-2018), the LTCG from Direct Equity and Equity MFs (where STT is paid) was tax-free, without any limit, but this route has been blocked now.

Now, few of you may ask – What do you want to convey? As that Professor asked in movie 3 Idiots – Kehna kya chahte ho? Here it goes.

We, the average retail investors, put too much attention on INCOME TAX and the instruments, where the income MUST BE TAX FREE. The budget announcement of LTCG from Equity is not accepted well by the investor community. Let me remind you – Before Introduction of STT (securities transaction tax) in October 2004, by the Govt of that time, the LTCG from Equity was fully taxable. It was having dual Tax rates – either flat 10% or Indexed gains at 20%. The tax payer was allowed to opt any one of the rates, where the tax rate is favorable.

If the Equity LTCG was taxable, why it was made Tax free? Look closely. It was not tax-free from October 2004 to 31st March 2018. Govt charged the STT at a very small rate and let us enjoy the major part of gains. Why? At that time in 2004, not many of us were investing in Equity. Those were investing, were not reporting properly. The Govt was not having requisite infrastructure in place to track down each and every individual transaction. So Govt went into a compromise and allowed the very small rate of STT to be applied at source (Stock Exchanges or AMCs), on transactions. This way, Govt. was able to capture all the transactions happening in Stock exchanges and AMCs. In parallel, KYC norms, linking of PAN, CBS in banks and the very Income Tax department’s own infrastructure were prepared. Once all things become ready, it was not the question of WHY? It was, WHEN? the Govt. bite the bullet and announced the reintroduction of Tax on LTCG from Equity.

In parallel to above, Govt has blocked/tried several other routes of either tax-free income or tax evasion. Sample this –

  1. Earlier Dividend income from Direct Equity was tax-free without any limit. Now Dividend Income more than Rs. 1000000 (in words Ten Lakh) is taxable at flat rate of 10%.
  2. First through Direct Tax Code in August 2009 and later on in Budget 2016, Govt tried to make EPF and PPF Taxable.
  3. 1% TDS on Property deals, where property value is more than Rs. 5000000 (in words Fifty Lakh) since 2013
  4. Restricting Home loan interest benefit on rented properties to just Rs. 200000 (in words Two Lakh)
  5. Mandatory linking of PAN with almost all Financial Transactions

You, the blog readers can point out several other measures.

What’s TAX FREE today, we can’t take it granted to remain TAX FREE forever. Today EPF/PPF/SSY are tax-free. The tax-free bonds are not issued fresh, hence these are now already not a new source for fresh money input to earn tax-free income in future continuously.

So my dear friends, stop cribbing about addition of Income Tax on old tax-free instruments or not getting new instruments. Be flexible. Just imagine, if EPF is merged into NPS, what’ll you do? If investment in PPF is restricted for those earning income above a cut off point (NRIs can’t invest in PPF already)? If Inheritance is made Taxable?

What is way forward? Start creating multiple Tax identities within family, within rules and legal frame-work. Those of you, who are already earning higher Tax rate primary income, should focus on HOW TO SHIFT SECONDARY INCOME TO SOME ONE ELSE’S NAME in the family.

Important point – I’m asking to do Tax Avoidance and not asking you to go for Tax Evasion. Remember the TAX AVOIDANCE is known as TAX PLANNING and allowed within the rule book. TAX EVASION  is not allowed.

IMPORTANT POINT- When you people read the word GOVT – you associate this with the sitting or representing face of the chair (be it Prime Minister or Finance Minister). If you look closely in all the information provided above, you’ll notice a pattern, irrespective of who sit in that chair, the whole system, the administration, the machinery, is moving in ONE SINGLE DIRECTION – MAKE EACH AND EVERYTHING TAXABLE. To me, the Govt is always the system, the administration, the machinery, the mechanism and of course the Babus (the bureaucrats, who are actually running the show).
Please do tell me, how are you planning to become flexible and future shock proof your portfolios from the impact of INCOME TAX? I’m waiting for your replies.

P.S. – Please stay away from making any political comments in favor of or against one political party/thought process or other side.

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Term Plan beyond earning age: Is it Worthy?

November 27, 2018

Indian Life insurance landscape has changed a lot in last 2 decades or so, since the private insurers were allowed to operate in India. There was a time, only LIC was there as a monopoly and in the name of term plan, the product basket was near empty. Yes, those of you, who are old enough and might had purchased, there were plans like Bima Kiran, having Sum Assured ranging from few thousands to single digit lakhs. On top of that, this was a RETURN OF PREMIUM PLAN – ROP.

Look at today, we have 24 life insurance companies as on date (Source) doing business in India. Each one of these are having various combinations of Term Plans. One interesting observation caught my eye. Almost all insurers are now offering Term Plans well beyond the Retirement age in India. Ranging from 75 to 80Y age and few insurers are offering plans up to age 99 to 100.

A basic question to my blog readers and this is also the header of this blog post – Is it worthy to have a term plan going well beyond your retirement age, till 75-80-99-100?

To answer the above question, first we need to answer few associated questions?

  1. Why do we need life insurance?
  2. Why do we need purest form of life insurance – Term Cover or Term Plan?
  3. How much sum assured one needs to have in term cover?
  4. Do we need to purchase Riders along with Term cover?
  5. What premium payment term -PPT, should we have for our Term cover?

Let’s discuss the answers for above questions –

  1. To cover the financial loss, of our income, we bring to our families and dependents, resulting out of our DEATH.
  2. The premium for a high sum assured + investment – combo policy will be so high that We can’t afford to pay. Also it’s advisable to keep INSURANCE and INVESTMENT needs separate.
  3. There are various ways to assign Human Life Value but the most simplistic is to have a Sum assured, which can substitute your income, if the same money is kept in a simple product like BANK FIXED DEPOSIT. In simple words, 15-17 times multiple of your yly income can generate the same income, at current Bank FD interest rates of 6-6.5%. One bonus information, Most insurers don’t offer term cover beyond 20 times multiple of your yly income, taken together your all life insurance policies’ sum assured.
  4. Please avoid riders along offered for a premium with your term plan, as these are neither offering adequate money not cover for the intended use and are very restrictive in their own definitions.
  5. If you are a salaried or a professional with a fixed and predictable monthly income, opt for Regular Premium Payment Term. Limited or Single Premium Payment Term should be opted only by those people who are not sure of their future cash flows.

Here comes the interesting part – Your responsibility towards your family or loved ones’ bright future doesn’t end with purchasing merely a Term Plan and paying it’s premium regularly. No. Purchasing the term plan, is merely the first step. Once it’s taken, the logical next step is to start working on creating a corpus, which is large enough to sustain your dependents in your absence, till your desired time. Once this corpus is in place, answer on your own, do you need a TERM COVER?

In several discussions with people, either over phone calls or in our Facebook group – asan ideas for wealth or one to one chats, one thing I noticed – people don’t see it wrong to purchase term cover well beyond earning age and the primary reason given – this sum assured will help a bit or become a gift, to my loved ones (specially the 3rd generation).

My view – If during your earning years, you could not create enough corpus to sustain your own retirement life as well as to leave some inheritance for your next generation, it indicates a failure of financial planning done by you during your productive years – Active Income Earning Years. Barring few exceptional cases where due to late marriage or late child births or any other special family situations, most people will be able to complete their financial obligations towards family members and loved ones, either through active income already or by creating enough corpus for the intended use, if events are to be happened in post retirement life.

Now Sample this, if a 25Y old person purchase a term cover of Rs. 10000000 (One Crore) till age 100, what’s happening in terms of TIME VALUE OF MONEY? We are aware that INFLATION eats away the purchasing power of our money. On a simple note, if inflation is 7%, the Rs. 100 in our pocket today, will only be worth of Rs. 93 (adjusted for 7% inflation) after 1Y, in today’s value. Please go through the attached excel sheet to notice the impact of inflation over your lifetime for your sum assured.

time value of 1 Crore till age 100

Now answer honestly, how much happy will be your loved ones at your age 100, if you gift them money through your DEATH CLAIM which is equal to Rs. 43274 at your age 25? It can’t even cover your FUNERAL EXPENSES.

 


The Ant and Grasshopper : 21st Century

August 12, 2018

Almost all of us have either read or listen the old story of Ant and Grasshopper. Many of us are now a days aware of jokes created around this simple yet beautiful story. In this blog post, I’m trying to take the old background to convey the point, I want you to understand.

Once upon a time, there were 2 friends – Miss Ant and Mr. Grasshopper. Both belonged to same neighborhood. Both went to same schools and colleges and ended up earning same university degrees. After finishing their college education, both landed into similar job profile but in different companies but in same city.

Mr. Grasshopper was also aware of the FAMILY HISTORY of his forefather, generations ago and the misadventures of that forefather, so from his first paycheck, he started investing for a Goal.

Miss Ant on the other hand was also aware of her family history and to continue the family reputation, legacy, she was equally hard working and laborious like her older generations. She also started saving from her first paycheck, for a financial Goal.

Both were having a common Goal – To create a Corpus of Rs. 10000000 (One Crore) in next 15Y. The readers are thinking till this point, each and everything is common the life of these 2 characters of our story. Where is the difference? Please hold on with me. Here is the difference.

For their future Goal – the expected return figure, Miss Ant opted for was 10% (Post Tax).

Mr. Grasshopper was true to his family legacy and thus opted for 15% (Post Tax) figure.

With the help of so many calculators, excel sheets and more, both came to a conclusion, if no increment is made in these 15 years, the fixed monthly amount to be invested in, to reach the corpus of 1 Crore is as below.

Miss Ant            Rs. 25081

Mr. Grasshopper Rs. 16424.

Real twist in the story comes here on wards. Although these friends were investing their money on monthly basis, regularly but the performance of Market was not in their control and hence the corpus created was as below.

Case-1

Actual performance of market was just 8%. Yes, you read it right – 8% only. So the Corpus value for both friends after 15Y was as below.

Miss Ant            Rs. 8472852

Mr. Grasshopper Rs. 5548348

Case-2

Actual performance of market was 12%. So the Corpus value for both friends after 15Y was as below.

Miss Ant            Rs. 11839590 or 1.18 Crore

Mr. Grasshopper Rs. 7753018 or 

Case-3

Actual performance of market was 18%. So the Corpus value for both friends after 15Y was as below.

Miss Ant            Rs. 19845327 or 2 Crore (almost)

Mr. Grasshopper Rs. 12995481 or 1.3 Crore (almost)

Story ends here but readers of this blog, needs to introspect on their financial life. Are you having Traits of Mr. Grasshopper or you are more similar to Miss Ant?

The lesson – Instead of chasing RETURN from Market, start putting more money to work.


GST on exit load in Mutual Funds.

June 6, 2018

In it’s recent meeting of GST council, it was proposed and accepted to levy GST on the exit load charged by Mutual funds. How it’s going to impact us, the investor? Let’s discuss it and try to understand it here.

Before we move ahead, please do understand, Exit load is always charged on the redemption amount and not on your invested amount. So no matter, you are redeeming in profit or loss, if Exit load is applicable to your redemption, it’ll be levied on your redemption amount.

Let’s assume, we are redeeming Rs. 10000 (ten thousand) and the applicable Exit load is 1%. So here goes the calculations for pre GST and Post GST situations.

Case 1 – Pre GST 

A. Redemption amount = 10000

B. Exit load @ 1% = 100

C. Net redemption amount in your bank account = A – B = 10000 – 100 = 9900

Case 2 – Post GST

A. Redemption amount = 10000

B. Exit load @ 1% = 100

C. GST @18% of B = 18

D. Net redemption amount in your bank account = A – (B+C) = 10000 – (100+18) = 9882

Now one interesting thing for your information, the exit load is not the profit of AMC. As per SEBI mandate, it’s added back as part of assets of fund for the remaining investors. So, what’s the difference now for this exit load addition, for old investors, who are not redeeming?

Nothing. That 100 in our example was added in pre GST era as well as now also in Post GST era.

One important point, the exit load and GST there on, does not impact your Short or Long Term Capital Gain Tax liability. For tax calculation, your redemption amount is still 10000 in our example.


The TAX SAVING in NPS – A Calculation

January 15, 2018

A lot of young earners are fascinated with the additional tax saving offered by NPS for an investment of Rs. 50000, every FY under section 80CCD(1b). Here I’m going to check the impact of TAX saving. Are we really saving tax today?
To get the answer or to start a calculation, few assumptions are made. Here are the assumptions for your kind considerations – the readers of this blog.

The investor aka NPS subscriber –

  1. Age 30Y old at the time of first investment in NPS.
  2. Only Rs. 50000 yly is invested at the start of year, here year means Financial Year.
  3. The retirement is taken at age 60Y. So the total investment period is 30Y.
  4. The corpus is growing at 12% rate in all these 30Y.
  5. Total amount over these 30Y, invested in NPS is Rs. 1500000 (50000*30 = 1500000).
  6. The maturity value of NPS at age 60Y is Rs. 13514630
  7. The 40% corpus is withdrawn tax free. Another 20% is withdrawn taxable and remaining 40% is used to purchase annuity from LIC under it’s immediate annuity plan, where, the Annuity (pension) is payable Yly for both husband and wife and after death of both, the purchase price is returned to to nominee/legal heirs. Point to be noted, the data available on LIC site, showing an annuity rate of 6.3% (roughly) for age 60Y person.
    Investment year Maturity year Year to remain invested The growth rate @ 12% Growth multiple Amount Invested Corpus for each individual investment Tax saving in 30% tax slab. Tax saving in 20% tax slab.
    2018 2048 30 1.12 29.95992 50000 1497996.1 15450 10300
    2019 2048 29 1.12 26.74993 50000 1337496.5 15450 10300
    2020 2048 28 1.12 23.88387 50000 1194193.3 15450 10300
    2021 2048 27 1.12 21.32488 50000 1066244 15450 10300
    2022 2048 26 1.12 19.04007 50000 952003.61 15450 10300
    2023 2048 25 1.12 17.00006 50000 850003.22 15450 10300
    2024 2048 24 1.12 15.17863 50000 758931.45 15450 10300
    2025 2048 23 1.12 13.55235 50000 677617.36 15450 10300
    2026 2048 22 1.12 12.10031 50000 605015.5 15450 10300
    2027 2048 21 1.12 10.80385 50000 540192.41 15450 10300
    2028 2048 20 1.12 9.646293 50000 482314.65 15450 10300
    2029 2048 19 1.12 8.612762 50000 430638.08 15450 10300
    2030 2048 18 1.12 7.689966 50000 384498.29 15450 10300
    2031 2048 17 1.12 6.866041 50000 343302.04 15450 10300
    2032 2048 16 1.12 6.130394 50000 306519.68 15450 10300
    2033 2048 15 1.12 5.473566 50000 273678.29 15450 10300
    2034 2048 14 1.12 4.887112 50000 244355.61 15450 10300
    2035 2048 13 1.12 4.363493 50000 218174.66 15450 10300
    2036 2048 12 1.12 3.895976 50000 194798.8 15450 10300
    2037 2048 11 1.12 3.47855 50000 173927.5 15450 10300
    2038 2048 10 1.12 3.105848 50000 155292.41 15450 10300
    2039 2048 9 1.12 2.773079 50000 138653.94 15450 10300
    2040 2048 8 1.12 2.475963 50000 123798.16 15450 10300
    2041 2048 7 1.12 2.210681 50000 110534.07 15450 10300
    2042 2048 6 1.12 1.973823 50000 98691.134 15450 10300
    2043 2048 5 1.12 1.762342 50000 88117.084 15450 10300
    2044 2048 4 1.12 1.573519 50000 78675.968 15450 10300
    2045 2048 3 1.12 1.404928 50000 70246.4 15450 10300
    2046 2048 2 1.12 1.2544 50000 62720 15450 10300
    2047 2048 1 1.12 1.12 50000 56000 15450 10300
    1500000 13514630 463500 309000

    7. Now check the next table.   Here it goes.

    Tax free 40% withdrawal Taxable 20% withdrawal 40% Annuity purchase amount Yly annuity amount
    5405852.1 2702926.1 5405852  340713
    Tax @30% on withdrawal 835204.15 105280.3
    Tax @20% on withdrawal 556802.77 70186.85

    From the 2nd table How many of you can see the impact of TODAY’s TAX SAVING resulting in a larger TAX outgo tomorrow?
    Point to be noted, the tax outgo on annuity is lifelong. Year after year, till the couple is surviving.


Social Economics

November 13, 2015

I received this as an E-mail. Copy pasted and hence do not claim that it’s my own work. Blog readers are free to learn their own lessons from this post.

An economics professor at a local college made a statement that he had never failed a single student before, but had recently failed an entire class. That class had insisted that Obama’s socialism worked and that no one would be poor and no one would be rich, a great equalizer.

The professor then said, “OK, we will have an experiment in this class on Obama’s plan”. All grades will be averaged and everyone will receive the same grade so no one will fail and no one will receive an A…. (substituting grades for dollars – something closer to home and more readily understood by all).

After the first test, the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy. As the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too so they studied little.

The second test average was a D! No one was happy. When the 3rd test rolled around, the average was an F.

As the tests proceeded, the scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else.

To their great surprise, ALL FAILED and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great, but when government takes all the reward away, no one will try or want to succeed.

These are possibly the 5 best sentences you’ll ever read and all applicable to this experiment:

1. You cannot legislate the poor into prosperity by legislating the wealthy out of prosperity.

2. What one person receives without working for, another person must work for without receiving.

3. The government cannot give to anybody anything that the government does not first take from somebody else.

4. You cannot multiply wealth by dividing it!

5. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that is the beginning of the end of any nation.


Asking right questions

November 9, 2015

Many readers of this blog are aware of PV Subramanyam. He writes a blog http://www.subramoney.com Many a times, he has asked to readers on asking right questions  to the advisers or planners or agents or sellers of financial products. Why does he say so?

My dear friends, personal finance is also about asking the right questions. Below is an old joke. Please read and understand it.

Two men went into the church and questioned to father.

Man 1 – Father, I’m drinking my glass of wine and suddenly, there is a desire within me to remember God, to pray him. Should I do it?

Father’s Ans. – My dear Son, God can be remembered any time. Please feel free to do so.

Man 2 – Father, I’m praying to God, remembering him and suddenly there is a desire within me to have a glass of wine. Should I do it?

Father’s Ans. – How dare you to do it? When you are in prayer, you should only remember God and nothing else.

Joke is over. Can you people get the point, this joke is about? Both the men were doing the same thing. Mixing drinking and prayer. Yet the answers to both were different.

Now go out and search for right questions within you, so that next time you get the right answers.