Tax Free Bonds – who should invests?

This seems to be the season for tax free bonds.  We have already seen issues from REC, HUDCO and IIFCL; and now, PFC and NHPC have join the bandwagon.  Significant efforts are spent by media in analyzing all the issues i.e. what they offer to investors and which is the best one to invest.  In this article, we shall not look into that but focus more on who should invest in such issues and what aspects the investor needs to take care of before investing in tax-free bonds.  Before that, a synopsis of the ongoing PFC and NHPC bond issue.

PFC and NHPC issue

Bond issues for PFC and NHPC are open right now offering bonds for 10, 15 and 20 years for similar tenure.  Below are the brief details about both the bond issues:

The issue is priced at attractive rates which is same for both PFC and NHPC issue.  These being tax free bonds, any interest received on these bonds is tax free. Accordingly, if one considers pre-tax returns, they are higher than what long term debt mutual funds have provided in last 5 years (7.83% p.a. pre-tax returns as per Value Research).

Pre-tax Returns on PFC and NHPC tax free bonds

Interest Rates	Tax Bracket
	10%	20%	30%
8.43%	9.37%	10.54%	12.04%
8.79%	9.77%	10.99%	12.56%
8.92%	9.91%	11.15%	12.74%

Who should invest in such bonds?

The interest rates are excellent, risk is at the nadir and tenure is long term.  So whether all and sundry should invest in such bonds?  The answer obviously is no.  One needs to take care of following aspects before deciding to invest in these and any other tax-free bonds:

1. This is a long term investment.  Though the bonds are listed and can be traded, one needs to assume that they will not get back the money before the tenure of investment.  Even if there is 1% probability of you requiring the money anytime during the tenure, then one should not consider this investment. 
2. The pre-tax returns decreases for investors falling in lower tax brackets.  So in case you are in 30% tax category bracket, the investment makes more sense to you rather than for people falling under 10% tax category bracket.
3. If you have any loans outstanding, whether it is credit card loan, personal loan, car loan, home loan, etc, the money should be utilized in paying back the loan rather than investing in tax free bonds.
4. These bonds offers good returns as compared to debt mutual funds.  In case you are looking for long term investment in debt funds, tax free bonds are also an option to invest.
5. People on the verge of retirement can replicate this as a pension plan with regular income.
6. PPF returns are almost at par with returns on tax free bonds, however PPF offers more flexibility in withdrawing the amount when required (e.g. by way of loan) and returns on PPF are cummulative.  Hence one should exhaust PPF investment limit before investing in tax free bonds.

The above list is not exhaustive, but one should take the same into account before investing in tax free bonds.

Are you investing in tax free bonds? Share your reason for investing in the comments section below.

Bachhat @ The Indian Blogger Awards 2013

Bachhat - Harvesting Money has been around for now almost 3 years.  Over this period, the blog has tried to help its readers understand personal finance and investing.  The blog has always tried to avoid doing run of the mill articles and has focused on articles and news which can be of value to its readers.

The blog has been nominated for the Indian Blogger Awards 2013 in 'Personal Finance' and 'Stocks' categories.  Indian Blogger Awards 2013 are hosted by Indibloggers and the winner shall be announced via twitter on the Independence Day.

If as a reader, you have benefited by this blog, we request you to recommend Bachhat for the awards by clicking on the following link and recommending the blog.  Link: http://www.indiblogger.in/iba/entry.php?edition=1&entry=53595

Thanks.

Debt Mutual Funds and Tax Implications – Recent changes in tax rates

Earlier Bachhat had written about how one can use ultra-short term debt funds to maximize post tax returns.  The article spoke about investing in dividend reinvestment plan of such funds, since dividend are effectively taxed at lower rate than short term capital gain rates and hence such funds are tax effective.

The tax rates on debt mutual funds were revised earlier during this year and hence the said article is not relevant in the current scenario.  Based on the revised tax rates, we have tried to analyse and tabulate which type of option (growth or dividend) should be chosen for investment in debt mutual funds.

Revised tax rates on debt fund

For an individual investor, short term capital gains in a debt mutual fund is taxable at tax slab under which such individual falls.  Long term capital gains are taxable @ 20% with indexation benefit and 10% without indexation benefit.  Surcharge @ 10% for taxable income of more than Rs. 1 crore and cess @ 4% shall apply additionally.

For dividend distributed, dividend distribution tax is applicable.  Earlier there was difference in dividend distribution tax rates between liquid / money market funds and other debt funds.  Now this difference has been eliminated and now dividend distribution tax on all debt funds shall be 25% (effective tax rate of 28.325% including surcharge and cess).

Growth or Dividend Option

One can maximize his returns from debt funds by choosing the correct option which has least tax implication.  Things to be considered before choosing a plan are:

1. Time period for investment
2. Tax bracket under which an individual falls
3. Need for regular income

Based on the above three criteria, the best option to choose from is as below:

When regular income is required

Since dividend distribution tax rate (28.325%) is higher than the effective tax rate for investors falling under 10% or 20% tax slab, it is beneficial for them to opt for growth option in case they are looking for investment horizon of less than 1 year and choose systematic withdrawal plan wherein a fixed amount shall be redeemed and paid to the investor at periodic interval.  SWP shall provide source of regular income to them.  However before opting for SWP under growth option, one needs to check out for exit load and commence SWP only after the exit load period. 

For individuals falling under 30% tax slab and in need of regular income, the tax benefit between dividend and growth option is minimal with dividend option slightly beneficial than the growth option.

For investment horizon of more than 1 year, it is beneficial for all investors looking for regular income to choose systematic withdrawal plan under the growth option.

When regular income is not required

For investors not looking for regular income, growth option is best irrespective of investment horizon.  However, there can be marginal tax benefit for investors falling under 30% tax slab by choosing dividend reinvestment option for investment horizon of less than 1 year.

Bachhat’s take

By increasing the dividend distribution tax rate, the tax advantage of dividend option which was available till late year has been eliminated, save for investors falling under 30% tax slab.  If an investor decides to invest in a debt mutual fund, he needs to take into consideration above aspects to increase his post-tax returns.  However one needs to keep in mind that the above analysis is relevant only till the tax rates are kept constant.  In case of any revision in tax rates (which may happen at the earliest in 2014 budget), the above may not hold true. 

Mutual Fund Tax Ready Reckoner for year 2013-2014

Continuing the initiative taken last year to provide a one stop solutions for tax implications on mutual fund investments, Bachhat has updated its mutual fund tax ready reckoner for the year 2013-2014.  

As you all are aware, mutual fund investors need to take into account plethora of tax rates to understand post tax returns.  Bachhat's mutual fund tax ready reckoner is an attempt to simplify and help mutual fund investors to determine the tax impact on their mutual fund investments.

You can view the ready reckoner by clicking on this link.  The link also provide rates for the last financial year (i.e. 2012-2013).

Are you aware about interest rate charged by your credit card company?

It has been long since Sanjay and Sanjana saw each other.  Both were busy in their respective work life.  In addition to that Sanjay was also studying for his professional course, which made it very difficult for him to meet Sanjana.  However, today being his birthday, both of them decided to meet up for lunch and spend the day together.

Sanjana was already waiting at an Italian restaurant when Sanjay arrives in new clothes looking smart.  Sanjana was visibly happy to see him after a long time.  She hugged him and gave birthday wishes.

“Gorgeous birthday boy, thanks for meeting me on your birthday at least. Otherwise where do you find time nowadays to meet me?”  as usual Sanjana started teasing him.

“Come-on Sanjana, you know how much busy I am at work and studying for the exams due next month.  I hardly get time for any other activities.” Sanjay started justifying himself.

Sanjana asked looking at the menu, “So how are your studies going on for the exams?”

“Still only half way through.  I need to devote more time on the studies for the remaining part of the month.  And better I do, otherwise the examination fees shall go in the drain so the loan I have taken.”  Sanjay started cribbing.

Not understanding what Sanjay is saying, Sanjana asked “What’s the relation between your exam and loan?” ordering pastas for both of them.  As usual, she made a choice about what Sanjay should also eat!

“Listen”, Sanjay started explaining, “For the exams, I need to pay examination fees, which were quite substantial and to pay that I took a loan on my credit card.  So if I don’t do well in exams, my loan will go waste.”

Sanjana replied, “Well…irrespective of how much I educate you on money part, you still waste your money.  Taking a loan on your credit card!   How can you make such big mistake?  Are you aware how much this loan cost you?”

“You always take me for granted.  Of course I have learned about and implemented money management.  Moreover, I have taken care of it while taking this loan also.”  Sanjay started his firm defense.

“Is it?  Tell me what did you take care of while taking the loan?”

“First, as you had told me earlier, I made a list of various options I had to take a loan.  Then I compared their terms, interest rates and ease of getting the loan.  Based on these criteria, the loan on credit card was the cheapest and easily available.” replied Sanjay, visibly satisfied with his explanation.

Smelling something fishy, Sanjana questioned, “How did you conclude that the loan on credit card was the cheapest?”

“It’s very simple.  In fact, they are giving me interest free loan.  They are only charging me processing fee of 5% on the loan amount and that’s all.  I only need to repay the loan amount in equal installments over 6 month’s period.  Since there is no interest, it is the cheapest of all”, replied Sanjay brimming with smile.

Stunned by the reply given, Sanjana yelled, “Credit card companies lure you with interest free loans and you fall prey of such offers.  Where did your learning of time value of money go?  Did you compare how much you are paying to credit card company for the loan and at what point of time?”

Seeing Sanjay a bit confused, Sanjana continued, “Listen.  Let me explain to you.  This all is gimmick of time value of money.  They charge you ‘interest’ on the entire amount in the name of processing fee and term it as interest free loan.

“Assume that instead of processing fee, it is 5% interest on loan amount which needs to be paid once at the time of disbursement of loan.  What the credit card company has done is to charge interest on the entire tenure of loan even though you are not using the full loan for the entire tenure.”

“I am not getting this.” confused, Sanjay replied, “Give me an example.”

“Look.” Sanjana started explaining, “For example you took a loan of Rs. 50,000 from your credit card company repayable in 6 equal installments of Rs. 8,333.  Reducing processing fee of 5% from the principal amount, net amount you receive is Rs. 47,500.  This you repay @ Rs. 8,333 in six equal installments.  Simple IRR (internal rate of return) calculations on your excel spreadsheet shall tell you that you have paid yearly interest of more than 19% on this loan amount.

“This is so since you paid the charges on the entire amount and not on the outstanding amount post your installments every month.”

Visibly upset by being again cheated Sanjay said, “I never thought of processing fees as interest cost.  I got lure by the claim that the loan is interest free and there is only one time charge.  But as you explained, time value of money is of utmost importance which calculating interest cost.”

“Bang on.  Now you are on the correct path.  Compare what you are receiving and paying along with the time periods and calculate the cost.  It is very simple to determine by way of excel spreadsheet.  And you shall get the interest cost on the loan you have taken.”  Sanjana added and continued,

“Now, don’t get upset birthday boy.  Let’s celebrate your birthday today and take this lesson as a ‘valuable’ gift from me to you on your birthday.” winked Sanjana.

Change in interest rates of PPF and other small savings schemes

Finance ministry has announced revised interest rates on public provident fund, national savings certificates and other small savings schemes.  These interest rates shall be applicable for financial year 2013-2014.  As we had noted earlier, interest rates of such schemes are now linked to market yields on government securities of comparable maturities and shall be revised every financial year.

Overall there has been a reduction in interest rates by 10 basis points (100 basis points is 1 percentage point) for all savings schemes except for saving deposits on which interest rates continues to be 4% and 1 year time deposits (8.2%).  Interest rates on PPF from April 2013 shall be 8.7% p.a. as against 8.8% p.a. earlier.

The table below summarizes the changes in interest rates:

Scheme	Existing interest rate	Interest rate w.e.f 1st April 2013
Savings Deposits	4.0	4.0
1 Year Time Deposit	8.2	8.2
2 Year Time Deposit	8.3	8.2
3 Year Time Deposit	8.4	8.3
5 Year Time Deposit	8.5	8.4
5 Year Recurring Deposit	8.4	8.3
5 Year SCSS	9.3	9.2
5 Year MIS	8.5	8.4
5 Year NSC	8.6	8.5
10 Year NSC	8.9	8.8
PPF	8.8	8.7

Overall there has been negligible change in the interest rates as compared to 2012-13.

Whether labeling makes it easier to invest in mutual funds?

Continuing with various regulatory changes in mutual fund space, SEBI earlier during this week mandated mutual funds to label their offerings.  The purpose of labeling is to address the issue of mis-selling by enabling investors an easy understanding of the kind of mutual fund scheme they are investing in and its suitability to them.

Changes suggested

With effect from 1^st July 2013, all mutual fund companies shall label their schemes on the following parameters:

1.  Nature of scheme: whether the scheme is to create wealth or to provide regular income and its time horizon - whether short, medium or long term.

2.  Investment objective: All schemes shall describe its objective in a single sentence along with whether it is an equity, debt or hybrid product.

3.  Riskiness of investments: which shall categorized the risk attached to return of principal amount.  To achieve this, SEBI has suggested colour codes as below:

·       Blue             – Principal at low risk

·       Yellow         – Principal at medium risk

·       Brown          – Principal at high risk

4.  Further all schemes shall have a disclaimer that if the investors are not clear about the suitability of the products, they should consult their financial advisers.

All key documents (such is Key Information Memorandum, Scheme Information Documents, etc) as well as scheme advertisements should prominently disclosed the above labels.

For example, Fixed Maturity Plan shall come with the below mentioned labeling.

Whether it actually simplifies the investment process for investors?

Though the intention of SEBI is good, one needs to see whether this simplifies the investment process for the investors.  It is difficult to categorize the investments based on risk.  One single rule cannot be applied everywhere. 

Are all debt schemes low risk investments?  For eg:  FMPs, in general, may have low risk of principal amount getting reduced but it depends on the kind of company the mutual fund scheme has invested in.  If the investment is in low quality / rated company, the actual risk coding should not be blue but yellow or may be brown in case of investment in junk papers. 

Nevertheless, this is a good attempt by SEBI to simplify mutual fund investing for investors.  These labels can be used as an initial screener to short list the schemes one wants to invest in, followed by more scheme specific evaluation.

What do you feel about the labeling of mutual funds?  Will this simplify your mutual fund selection process?  Do share your comments with us.

Bachhat on social networks

Dear Readers,

Bachhat - Harvesting Money is now on popular social networking sites.  Bachhat has been on facebook since some while.  Now we have also started a twitter handle for Bachhat.

The objective is to have more connections and interactions with our readers.

Twitter handle will primarily be used to provide instant updates on personal finance space.  Interesting articles on personal finance shall be shared on Twitter and Facebook page.

This blog shall continue to help you plan your personal finances effectively and efficiently.

Bachhat's Twitter Handle : @bachhat4u

Bachhat's Facebook page: http://www.facebook.com/bachhat

So why wait. Connect with us instantly and like us, share us and RT our tweets!

Regards,

Bachhat - Harvesting Money

Impact of Budget 2012 on Individual Tax Payers

I have tried to calculate the tax implications of various announcements made in Budget 2013 for individual tax payers.  The calculations are carried out for individuals for income slabs for Rs. 5 lakhs, Rs 7 lakhs, Rs. 10 lakhs, and Rs. 15 lakhs.

Do have a look at it.  But a word of caution, these calculations are based on various assumptions I have made and the final tax liability may be different for individuals having the same income.

Budget 2013 and Impact of taxes on your salaries

Time for prudence, restraint and patience

“In a constrained economy, there is little room to raise tax rates or large amounts of additional tax revenues. Equally, there is little room to give away tax revenues or the tax base. It is a time for prudence, restraint and patience.” 

This statement made by Honorable finance minister Mr. P.Chidambaram summarizes what is (or is not) in store for individuals in this budget.  There has been no change in the income slabs based on which tax is determined.  To benefit individuals who earn less than Rs. 5 lakhs per annum, a minuscule tax credit of rupees two thousand has been given.  Besides this there is hardly any permanent additional benefit for individuals in the budget.  Certain changes which shall impact your tax liability and determine your investments are covered below.

Interest on home loan eligible up to Rs. 2.5 lakh

An individual planning to purchase residential housing property shall get an additional deduction of Rs. 1 lakh on the interest amount paid to service the home loan.  However, this benefit comes with many riders.  First, this benefit is for individuals who do not own any residential properties at the time of sanction of loan amount.  Second, the value of such property should not exceed Rs. 40 lakhs.  Third, the home loan amount should not exceed Rs. 25 lakhs and it should be sanctioned in financial year 2013-14.  If the interest amount during the year is less than Rs. 1 lakh, the balance amount can be claimed in the subsequent year. 

Scope of RGESS widened

Rajiv Gandhi Equity Savings Scheme (RGESS) was introduced in the last budget to attract new retail investors to invest in equities.  The scope of the scheme has been increased to cover listed units of an equity oriented mutual fund and individuals having total income upto Rs. 12 lakhs are now elligible to claim this deduction.  The deduction, which was earlier restricted for one year, is now available for 3 consecutive years from the date of first such investment.

Other changes which impacts your investment decisions

The securities transaction tax (STT) on equity oriented mutual fund has been reduced which shall lead to increased returns from equity mutual fund investments.

On the other hand, dividend distribution tax on debt oriented mutual funds has been increased from 12.5% to 25% discouraging debt oriented mutual funds with dividend payout option.

Any transfer of immovable property, other than agricultural land, of value equal to or exceeding Rs. 50 lakhs shall attract 1%  TDS on the property value.

Further it has been proposed that where any immovable property is received for a consideration less than the stamp duty value of the property by an amount exceeding Rs. 50,000, the stamp duty value of such property as exceeds such consideration, shall be chargeable to tax in the hands of individual.

Commodity transaction tax has been introduced wherein sale of commodity derivatives (other than those involving agricultural commodities) shall attract transaction tax @ 0.01%.

On positive side, the finance minister has proposed introduction of inflation indexed bonds or inflation indexed national security certificates.  This shall give investor inflation adjusted interest returns and shall be a good investment alternative.  The tax free bonds, which provide tax free interest to the investors, shall continue to be issued in the next year.

(Concise version of the above post was printed in DNA's edition of 1st March 2013)