As you may be already aware the government has released a new tax code which it proposes to bring into effect from April 1st, 2011. Its stated goal is to reduce complexity and simplify the tax-process.
If they really wanted to simplify the process, then one of my suggestions to them would be to make the financial year same as the calendar year. I fail to understand why do we need to have FY 2008-09, why it can't be just FY 2008 , FY 2009 and so on like in few other countries. This was established by the British, and we have kept on following the same.
Let me first start with what has been taken away from you:
1. No more tax-free allowances like HRA ( house rent allowance ) , LTA ( leave travel allowance ) and medical allowance. All allowances and perks will be considered as part of your salary income. Gratuity is also taxable. Transport Allowance and travel allowance continue to be tax-free upto the limits prescribed.
2. Section 66 replaces section 80C. Only four kinds of tax-saving instruments are allowed:
- Pension fund
- Provident fund
- Life Insurance
- Superannuation fund
All withdrawals from the above funds are taxed even at retirement.
The only silver lining is that the accumulated balance in provident fund accounts upto March 31st, 2011 would continue to be tax-free.
ELSS mutual funds, NSC and 5-year fixed deposits would no longer be tax-savings instruments if the new tax code comes into effect.
3. Capital gains are fully-taxed. Gains can be indexed to the cost of inflation if the holding period is more than one year. This means that the tax-free long term capital gains offered by equity mutual would be history.
4. Dividends from equity mutual funds would also be taxable in the hands of the investors. Although DNA reports that the mutual fund dividends will continue to be tax-free under the new tax code, but as per my understanding the dividend received from mutual fund will be taxable because:
- Dividend is tax-free only if dividend distribution tax (DDT) has been paid.
- Equity mutual funds are not required to pay DDT ( only companies are required as per section 99 ), hence mutual fund dividends would be taxable.
5. No tax-benefit for interest on home-loan
Although, the govt has taken away so many benefits from you, they have also increased the tax slabs which means that for an income upto Rs. 10 Lacs you may pay a tax of 10% only ( will this also have education cess? ). The tax-savings limit has also been increased to Rs. 3 lakhs from the present Rs. 1 lakh, but where will you invest so much money since so many tax-savings instruments have been withdrawn. The only option is to spend it on health insurance or on your child's education. But if you are not married then how do you save tax? lock up your money in a EET plan?
The limit for wealth tax has also been increased to Rs. 50 crore but this will also include mutual fund & equity investments ( this means that Gold ETFs would also be counted as wealth ).
Overall, I feel the new tax code will not increase/decrease your annual tax outflow but it will affect the way in which you save. With many tax-savings instruments (like NSC) being withdrawn and the remaining ones being made EET ( exempt-exempt-tax ), the focus is reallly on building long term savings.
Some tips which I believe would be useful in the new tax-regime:
1. Since long-term capital gains are being removed, book all your long-term gains on March 31st, 2011. Then re-purchase the same on or after April 1, 2011. This way you can book tax-free profits if you have been holding a stock/equity mutual fund for long time.
2. The amounts deposited upto March 31st, 2011 in PPF are tax-free ( as also the interest earned on such amount ) and you still have two financial years, hence accumulate as much as you can in your PPF ( maximum deposit in a single year can be Rs. 70,000/- ). The interest earned on any such amount will continue to be tax-free. But this strategy may back-fire as the interest rates for PPF are controlled by the govt. and it may decide to set the PPF interest rate very low in order to discourage deposits in PPF.
3. In case you are afraid that the insurance companies do not offer good enough interest rates on annuity plans, you can decide to invest in a pension fund which is run by a mutual fund like UTI Retirement Benefit Pension Fund. In such a pension fund the amount is accumulated upto the retirement age and then you can start a SWP ( systematic withdrawal plan ) in order to receive your pension. Hence you are no longer dependent on the annuity rates offered by the insurance companies. Tax-benefits as applicable to other pension funds also apply here.
Showing posts with label pension. Show all posts
Showing posts with label pension. Show all posts
Tuesday, August 18, 2009
Monday, July 27, 2009
IRDA circular on ULIPs - good enough?
IRDA has issued circular number 20/IRDA/Actl/ULIP/09-10 placing a cap on ULIP charges.
In brief, the circular specifies the following:
- For policies with tenor less than or equal to 10 years the difference between gross and net yield cannot exceed 3 %
- For policies with tenor greater than 10 years the difference between gross and net yield cannot exceed 2.25 %
- At the time of maturity, the insurer must issue a certificate showing charges deducted, fund value and final payment made to the policyholder. The certificate must also contain the gross and net yield.
This does look like a good thing for the investor. But this does leave some unanswered questions :
1. Can this circular mean the death knell for the ignominious Fund Allocation charges, which could go as high as 80% in the first year?
2. Does this circular apply to ULIP retirement plans also?
3. As stated by Dhirendra Kumar in this article:
"It is strange that the most significant improvement in the disclosure has only been done to the statement that the policyholder will receive at maturity. So if your fifteen-year policy starts now, you have to wait only till 2024 to know the full details of what the insurer did with your money in 2009."
4. In the recently introduced "ICICI Prudential LifeStage Assure Pension" the first year premium is not invested in funds (i.e. fund allocation charge of 100% in the first year ). As per the IRDA circular existing schemes have to be modified to comply to these rules by December 31st, 2009. How can this scheme be modified to comply with IRDA regulations? Does that mean it will be wound up? ( I'm have not invested in LifeStage Assure Pension, I'm just curious to know its fate )
We have to wait for ULIPs which comply with these regulations in order to understand the extent to which it would benefit the investors.
One thing I can predict for sure, after this circular comes into effect after after October 1st, 2009, there will be more ULIPs launched with tenor less than 10 years since the insurance companies can charge you 0.75% more than for policies greater than 10 years policy. Also riders to the insurance policy will be pushed aggressively by the Insurance companies since the cost for riders benefits is not included in the calculation of net yield. Something similar was observed in Mutual Funds when SEBI banned NFO expenses for open-ended mutual funds. Large number of closed-ended mutual funds were launched since NFO expenses upto 6% could be recovered from the investor. SEBI ultimately plugged this loophole by banning NFO expenses for closed-ended funds as well.
In brief, the circular specifies the following:
- For policies with tenor less than or equal to 10 years the difference between gross and net yield cannot exceed 3 %
- For policies with tenor greater than 10 years the difference between gross and net yield cannot exceed 2.25 %
- At the time of maturity, the insurer must issue a certificate showing charges deducted, fund value and final payment made to the policyholder. The certificate must also contain the gross and net yield.
This does look like a good thing for the investor. But this does leave some unanswered questions :
1. Can this circular mean the death knell for the ignominious Fund Allocation charges, which could go as high as 80% in the first year?
2. Does this circular apply to ULIP retirement plans also?
3. As stated by Dhirendra Kumar in this article:
"It is strange that the most significant improvement in the disclosure has only been done to the statement that the policyholder will receive at maturity. So if your fifteen-year policy starts now, you have to wait only till 2024 to know the full details of what the insurer did with your money in 2009."
4. In the recently introduced "ICICI Prudential LifeStage Assure Pension" the first year premium is not invested in funds (i.e. fund allocation charge of 100% in the first year ). As per the IRDA circular existing schemes have to be modified to comply to these rules by December 31st, 2009. How can this scheme be modified to comply with IRDA regulations? Does that mean it will be wound up? ( I'm have not invested in LifeStage Assure Pension, I'm just curious to know its fate )
We have to wait for ULIPs which comply with these regulations in order to understand the extent to which it would benefit the investors.
One thing I can predict for sure, after this circular comes into effect after after October 1st, 2009, there will be more ULIPs launched with tenor less than 10 years since the insurance companies can charge you 0.75% more than for policies greater than 10 years policy. Also riders to the insurance policy will be pushed aggressively by the Insurance companies since the cost for riders benefits is not included in the calculation of net yield. Something similar was observed in Mutual Funds when SEBI banned NFO expenses for open-ended mutual funds. Large number of closed-ended mutual funds were launched since NFO expenses upto 6% could be recovered from the investor. SEBI ultimately plugged this loophole by banning NFO expenses for closed-ended funds as well.
Saturday, June 27, 2009
New Pension Scheme ( NPS ) - will I invest?
This post is only applicable to private-sector employees since all govt. employees ( who joined in or after 2004 ) are compulsorily part of the NPS.
Although this is old news, NPS is now open for all to invest in it. Being a private sector employee, I have done an analysis whether I will invest in it or not. Hopefully it would be useful to all the readers of my blog as well.
My verdict is I will not invest in it right now. The reasons are explained below:
1. Charges are high: As explained in this livemint article although the fund management charges are very low, the other charges are very high atleast for the initial years. As the number of subscribers grow these fixed charges will also come down and then it will a right opportunity to enter. It is better to invest your retirement money in other avenues until you decide to open a NPS account and later on you can deposit this accumulated sum into your NPS account if you wish. You can check out the NPS welcome kit found here to see the fixed and other charges.
2. No clarity on tax benefits: An explained in this Value Research article, there are no tax-benefits of investing in the NPS. Let the govt come up with proposals on what tax-breaks it is ready to offer to NPS investors. Hopefully they would do it in the budget being presented in July, 2009.
3. The equity part stands limited to Nifty: They should have either allowed the fund manager's discretion in choosing the stocks for equity investments or chosen a broader index like S&P CNX 500. This I suggest for the following 3 reasons:
a) I'm afraid large amounts of NPS money flowing into just 50 stocks would surely create a bubble of sorts for the Nifty stocks ( which will burst one day!).
b) Secondly, the broader indices like S&P CNX 500 although being more volatile over shorter terms have always beaten the Nifty/Nifty junior when compared over a time-period of 10 years or more. Retirement money being (very-)long term money should surely benefit from it.
c) Thirdly, they have appointed several different fund management companies but if all have to invest in the same Nifty-50 stocks in the same proportion ( i.e. follow the index ) then what is the point of having several different fund management companies.
4. Relying on the rating agencies: Remember the rating agencies who had rated the sub-prime CDOs as AAA? As explained by Deepak in this article, the original proposal drafted by committee headed by Deepak Parekh had sought to make the rating agencies irrelevant by putting the onus on the fund manager. But PFRDA decided to reverse it and now atleast 75% of the investments done in corporate bonds must be rated by one of the rating agencies. Is it a wise move considering the present economic crisis, the world is going through, is partly caused by trusting these ratings? Also the rated company pays the rating agency, so if one rating agency refuses to give them a good rating, the company takes their business to another rating agency whoever offers them a better rating for their bonds. This is a conflict which must be resolved before relying on ratings for making investment decisions.
5. EPS 1995: And lastly the most important reason why I will not contribute to NPS is because I ( being a private-sector employee ) am already contributing to this scam known as EPS 1995 ( full details in this article ). The government must scrap the EPS 1995 scheme and all of employee's ( and employer's contribution also ) retirement money ( irrespective of govt. or private-sector ) must go into NPS. All the existing money being held by EPS 1995 scheme should also be transferred to the respective employee's NPS account.
I have adopted a wait-and-watch policy. What about you?
Although this is old news, NPS is now open for all to invest in it. Being a private sector employee, I have done an analysis whether I will invest in it or not. Hopefully it would be useful to all the readers of my blog as well.
My verdict is I will not invest in it right now. The reasons are explained below:
1. Charges are high: As explained in this livemint article although the fund management charges are very low, the other charges are very high atleast for the initial years. As the number of subscribers grow these fixed charges will also come down and then it will a right opportunity to enter. It is better to invest your retirement money in other avenues until you decide to open a NPS account and later on you can deposit this accumulated sum into your NPS account if you wish. You can check out the NPS welcome kit found here to see the fixed and other charges.
2. No clarity on tax benefits: An explained in this Value Research article, there are no tax-benefits of investing in the NPS. Let the govt come up with proposals on what tax-breaks it is ready to offer to NPS investors. Hopefully they would do it in the budget being presented in July, 2009.
3. The equity part stands limited to Nifty: They should have either allowed the fund manager's discretion in choosing the stocks for equity investments or chosen a broader index like S&P CNX 500. This I suggest for the following 3 reasons:
a) I'm afraid large amounts of NPS money flowing into just 50 stocks would surely create a bubble of sorts for the Nifty stocks ( which will burst one day!).
b) Secondly, the broader indices like S&P CNX 500 although being more volatile over shorter terms have always beaten the Nifty/Nifty junior when compared over a time-period of 10 years or more. Retirement money being (very-)long term money should surely benefit from it.
c) Thirdly, they have appointed several different fund management companies but if all have to invest in the same Nifty-50 stocks in the same proportion ( i.e. follow the index ) then what is the point of having several different fund management companies.
4. Relying on the rating agencies: Remember the rating agencies who had rated the sub-prime CDOs as AAA? As explained by Deepak in this article, the original proposal drafted by committee headed by Deepak Parekh had sought to make the rating agencies irrelevant by putting the onus on the fund manager. But PFRDA decided to reverse it and now atleast 75% of the investments done in corporate bonds must be rated by one of the rating agencies. Is it a wise move considering the present economic crisis, the world is going through, is partly caused by trusting these ratings? Also the rated company pays the rating agency, so if one rating agency refuses to give them a good rating, the company takes their business to another rating agency whoever offers them a better rating for their bonds. This is a conflict which must be resolved before relying on ratings for making investment decisions.
5. EPS 1995: And lastly the most important reason why I will not contribute to NPS is because I ( being a private-sector employee ) am already contributing to this scam known as EPS 1995 ( full details in this article ). The government must scrap the EPS 1995 scheme and all of employee's ( and employer's contribution also ) retirement money ( irrespective of govt. or private-sector ) must go into NPS. All the existing money being held by EPS 1995 scheme should also be transferred to the respective employee's NPS account.
I have adopted a wait-and-watch policy. What about you?
Tuesday, December 9, 2008
Why the Employees' Pension Scheme (EPS) is a scam?
Whatever I write below is applicable only to employees of Private sector in India ( including IT and BPO employees ), since Govt. companies have their own separate pension fund ( as far as I know ).
Employees' Pension Scheme (EPS ) is operated by EPFO http://www.epfindia.com/ , the same organisation which handles your Provident Fund( PF ) as well.
12% of your Basic salary goes to EPFO.An equivalent amount is contributed by your Employer as well i.e. in total 24% of your basic salary goes to EPFO.
This amount ( i.e. 24% of your basic salary ) is allocated into different accounts as follows:
1. EPS - 8.33% of your basic salary goes towards EPS, subject to a maximum of Rs. 541/- (i.e. 8.33% of Rs. 6500 )
2. The rest of the amount goes into the PF account.
An example of this allocation can be found in this file.
You earn certain % of interest on the amount in your PF account. The rate of interest is decided by the Board of EPFO. Whatever is the amount accumulated in this PF account by the time you retire, you receive that as a lump sum.
But we are only interested in what happens to the amount deposited in the EPS account. The amount accumulated in your EPS account is paid back to you as a monthly pension after you retire.
Now it's time for some serious number crunching, here we go:
Ram joins a company at Age 25, works there for 35 years and retires at the age of 60.Let's assume his basic salary was Rs. 10,000/- from the beginning of his employement to his retirement.
Since his basic salary was greater than Rs. 6500/- the amount that went towards EPS was Rs. 541/- ( the EPS rules place a cap on the maximum basic salary which is used to calculate your contribution and your monthly pension )
After retirement his monthly pension would be calculated using the below formula:
( Pensionable salary X Pensionable service ) / 70
Here,
Pensionable salary = Rs. 6500/- (remember, EPS rules place a cap on basic salary )
Pensionable service= 35 years ( the number of years he was in service, and contributed to EPS )
So, the calculation yields.
( 6500 X 35 ) / 70 = Rs. 3250/- ( Ram's monthly pension )
i.e. his annual pension is Rs. 39,000/-
So now we need to calculate whether Ram got a fair deal. Whether this monthly pension paid to him was just?
Let's use a recurring deposit calculator, to estimate how much he would have accumulated in his EPS account by the time he retires. We assume a conservative rate of interest 8%
It would be Rs. 12,49,263/-
To calculate:
1.Go to this link
http://www.teacherone.com/Business/recur_deposit/recur_deposit_maturity_calculator.php
2. Enter amount as Rs. 541/-
3. Frequency of deposit: Monthly
4. Rate of interest: 8 %
5. Duration: 420 months ( 35 years X 12 months )
6. Press "Calculate Maturity amount" button. You will get 12,49,263
There are annuity ( i.e. immediate payment of pension ) schemes offered by public and private life insurance companies. Let's take LIC ( a govt. owned life insurer ).
It offers a scheme known Jeevan Akshay which is an immediate pension plan.
http://www.licindia.com/jeevan_akshay_plan_009_features.htm
A PDF printout of the page in this link is here.
Observe the table on top of Page 2 of this PDF file.
For Rs. 1 lakh price, anyone retiring at age 60 can get a annual pension Rs. 9350/- ( constant and guaranteed for his lifetime )
Since Mr. Ram has Rs. 12,49,263/- with him ( I am assuming that the amount accumulated in his EPS account is given back to him on retirement, but as per the rules this does not happen ), let's calculate how much annual pension he can get from LIC. We use the premium calculator available on LIC's website to do this.
1. Go to this link. http://www.licindia.com/premium_calculator.htm
2. Choose Jeevan Akshay from the drop-down.
3. Press on 'Select Product' button.
4. Enter date of birth as 31/12/1947, so that he is 60 years today.
5. Enter purchase price as 1249263 (the amount accumulated in Mr. Ram's EPS)
6. Annuity type is" Annuity payable for life"
7. Annuity mode is yearly.
8. Press on Calculate premium button.
The annual pension is shown to be Rs. 1,21,803/-
This translates into a monthly pension of approx. Rs. 10,000/-
What a scam!!!
A person who deserves a monthly pension greater than Rs. 10,000/- is paid only peanuts ( Rs. 3250/- ) by the EPFO.
This is a scheme by the Govt and for the Govt, to cheat people of their retirement money. Anybody who has the option to take money out of EPS scheme and purchase annuity on his own, will get three times the pension he gets from EPFO.
PS: EPS rules can be found at this link
http://www.epfindia.com/Circulars/EPS95_update102008.pdf
Disclosure: I am not an accountant or CA and the above calculation is as per my understanding of the EPS rules. I am writing this post so that an qualified CA can comment on the above, whether my concerns are genuine. If you know a CA or accountant, please pass this blog post on to him and ask his opinion on it.
Employees' Pension Scheme (EPS ) is operated by EPFO http://www.epfindia.com/ , the same organisation which handles your Provident Fund( PF ) as well.
12% of your Basic salary goes to EPFO.An equivalent amount is contributed by your Employer as well i.e. in total 24% of your basic salary goes to EPFO.
This amount ( i.e. 24% of your basic salary ) is allocated into different accounts as follows:
1. EPS - 8.33% of your basic salary goes towards EPS, subject to a maximum of Rs. 541/- (i.e. 8.33% of Rs. 6500 )
2. The rest of the amount goes into the PF account.
An example of this allocation can be found in this file.
You earn certain % of interest on the amount in your PF account. The rate of interest is decided by the Board of EPFO. Whatever is the amount accumulated in this PF account by the time you retire, you receive that as a lump sum.
But we are only interested in what happens to the amount deposited in the EPS account. The amount accumulated in your EPS account is paid back to you as a monthly pension after you retire.
Now it's time for some serious number crunching, here we go:
Ram joins a company at Age 25, works there for 35 years and retires at the age of 60.Let's assume his basic salary was Rs. 10,000/- from the beginning of his employement to his retirement.
Since his basic salary was greater than Rs. 6500/- the amount that went towards EPS was Rs. 541/- ( the EPS rules place a cap on the maximum basic salary which is used to calculate your contribution and your monthly pension )
After retirement his monthly pension would be calculated using the below formula:
( Pensionable salary X Pensionable service ) / 70
Here,
Pensionable salary = Rs. 6500/- (remember, EPS rules place a cap on basic salary )
Pensionable service= 35 years ( the number of years he was in service, and contributed to EPS )
So, the calculation yields.
( 6500 X 35 ) / 70 = Rs. 3250/- ( Ram's monthly pension )
i.e. his annual pension is Rs. 39,000/-
So now we need to calculate whether Ram got a fair deal. Whether this monthly pension paid to him was just?
Let's use a recurring deposit calculator, to estimate how much he would have accumulated in his EPS account by the time he retires. We assume a conservative rate of interest 8%
It would be Rs. 12,49,263/-
To calculate:
1.Go to this link
http://www.teacherone.com/Business/recur_deposit/recur_deposit_maturity_calculator.php
2. Enter amount as Rs. 541/-
3. Frequency of deposit: Monthly
4. Rate of interest: 8 %
5. Duration: 420 months ( 35 years X 12 months )
6. Press "Calculate Maturity amount" button. You will get 12,49,263
There are annuity ( i.e. immediate payment of pension ) schemes offered by public and private life insurance companies. Let's take LIC ( a govt. owned life insurer ).
It offers a scheme known Jeevan Akshay which is an immediate pension plan.
http://www.licindia.com/jeevan_akshay_plan_009_features.htm
A PDF printout of the page in this link is here.
Observe the table on top of Page 2 of this PDF file.
For Rs. 1 lakh price, anyone retiring at age 60 can get a annual pension Rs. 9350/- ( constant and guaranteed for his lifetime )
Since Mr. Ram has Rs. 12,49,263/- with him ( I am assuming that the amount accumulated in his EPS account is given back to him on retirement, but as per the rules this does not happen ), let's calculate how much annual pension he can get from LIC. We use the premium calculator available on LIC's website to do this.
1. Go to this link. http://www.licindia.com/premium_calculator.htm
2. Choose Jeevan Akshay from the drop-down.
3. Press on 'Select Product' button.
4. Enter date of birth as 31/12/1947, so that he is 60 years today.
5. Enter purchase price as 1249263 (the amount accumulated in Mr. Ram's EPS)
6. Annuity type is" Annuity payable for life"
7. Annuity mode is yearly.
8. Press on Calculate premium button.
The annual pension is shown to be Rs. 1,21,803/-
This translates into a monthly pension of approx. Rs. 10,000/-
What a scam!!!
A person who deserves a monthly pension greater than Rs. 10,000/- is paid only peanuts ( Rs. 3250/- ) by the EPFO.
This is a scheme by the Govt and for the Govt, to cheat people of their retirement money. Anybody who has the option to take money out of EPS scheme and purchase annuity on his own, will get three times the pension he gets from EPFO.
PS: EPS rules can be found at this link
http://www.epfindia.com/Circulars/EPS95_update102008.pdf
Disclosure: I am not an accountant or CA and the above calculation is as per my understanding of the EPS rules. I am writing this post so that an qualified CA can comment on the above, whether my concerns are genuine. If you know a CA or accountant, please pass this blog post on to him and ask his opinion on it.
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