Survey Results - How do individuals plan their tax related investments?

Every individual, whether salaried or in business, tries to ensure that his tax outgo is at the minimum.  Tax-related investments such as Provident Fund, Equity Linked Saving Schemes, etc form major avenues of saving taxes.  Each year, in the months of February and March, insurance and mutual fund companies heavily advertise their products to lure the last minute rush by individuals to save their tax.  New tax-saving products are launched by these companies to cash in the tax fever.

Whether the insurance and mutual fund companies benefit by launching their products in the last quarter of the year?  How do tax payers plan their tax related investments?  Do they plan their investments early or they rush for investments during the year-end?  Which is the favourite instrument of tax saving for individuals?

Bachhat did a survey amongst its readers to gain answers to these questions and the responses were a bit surprising.  Total of 49 individuals participated in the survey.  Almost all the participants were salaried employees and more than 75% of the participants were less than 30 years old.

Key Takeaways from the Survey

 

  

 * sum of all percentages will be more than 100, since few individuals have chosen more than one option.

 

1.    Only 24% out of all respondents make major part of their tax investments in the months of January to March.  Most individuals (59%) spread their investment over the entire year.  This is contrary to the popular belief that people wait till year end for tax planning.  This also correlates perfectly with the outcome of the other survey question on where do the individual invests (See Point 2).

2.    Provident Fund (78% of respondent have invested either in PPF, EPF or both) and Life Insurance (72%) are most popular investment options for tax planning.  Home Loan is also a significant component for those who have opted for it.  Since both EPF and Home Loan are periodic payments, major portion of the 80C investments are spread over the entire year and supports the findings in Point 1 above.

3.    Pension Fund (20%) and Bank Fixed Deposits (16%) are the least prefer investment options.  The quantum of investment in these instruments is also less as compared to other alternatives.

 

4.    16% of the respondents pay more than Rs. 50,000 for life insurance cover, where as significant 20% pays between Rs. 25,001 to Rs 50,000.  Taking note of the fact that life insurance coverage in India is low and pure term insurance does not cost much, the above findings justify that many individuals invest in insurance + investment products offered by the insurance companies.

5.    Infra Bonds are yet to find flavor amongst individuals (mainly due to low interest rate on offer) with only 42% individuals investing in the same.

6.    Similar for health insurance cover with just 42% of individuals opting for it.  However, this figure does not take into account the health cover provided by employer to their employees.

Are you an exception to the above findings or does your tax planning replicate this?  Do share your comments and suggestions.  Thanks.

Where do I invest my savings? [Part 1]

Indians, traditionally, are good savers. As per the latest Economic Survey of India, household savings was 22.6% in 2009-10 and has now been stable for past three years. This means Indians, on an average, saves roughly ¼ of their earnings. 

However, the good part ends here. Most of these savings (roughly 50%) goes into fixed deposits and savings account. There is nothing wrong in parking your funds in fixed deposits however; fixed deposits are not an ideal instrument for long term savings. They are capital-protection investment and not wealth creation investment avenues. They provide minuscule returns after adjusting for inflation. And in times like today when inflation is increasing, they offer negative returns i.e. a case where inflation is more than the interest rate. Add to above, the interest earned on fixed deposit is taxable. Hence your actual income after taking into account the inflation and taxes is negligible. On the positive side, it is risk-free and provides liquidity, capital protection and predictability of cash flows.

For long term investment one should look beyond fixed deposits. There are various wealth creation alternatives available which have an ability to provide enhance returns with proportionate increase in risk.  In this post we shall discuss the various alternatives available for an individual investor.  Note that the alternatives discussed here are keeping in mind what should form part of an average individual investor’s portfolio. For high net worth individuals, there may be more exotic alternatives available which are outside the purview of this post.

1. Fixed deposit: The pros and cons of fixed deposits are already discussed above. However, it is better to have funds in fixed deposits rather than in savings account.
2. Provident Fund: It can be in the form of public provident fund (PPF) where an individual can invest up to Rs. 70,000 per annum or Employees Provident Fund (EPF) where employee as well as employer makes periodical contribution. They get preferential treatment in taxation and are good source for retirement savings. It should form part of any individual’s portfolio. The investment earns a good tax-free interest. Generally the rate of interest on EPF is more than PPF, however both have different tenures. 
3. National Savings Certificate (NSC): It provides return of 8% and is virtually risk free. The tenure is for six years and contribution as well as interest earned is tax-free within the limits of Sec 80C of the Income-tax Act.
4. Kisan Vikas Patra (KVP): Similar to NSC, it is risk-free long term investment plan. It provides 8.25% return over an investment horizon of eight years and seven months.  Unlike NSC, premature withdrawals are permitted after two years and six months.  However there is no preferential tax treatment and interest is taxable.
5.  Corporate Debts and Company Fixed Deposits: These are debentures and fixed deposits issued by companies. They are available for the tenure of 1 year to 10 years. Debentures or deposits of good corporate are low risk investments and one can earn higher interest as compare to fixed deposit. Now it is mandatory to list the debenture on stock exchange and is regularly traded albeit with small volumes. Hence liquidity may be a problem for substantial investment.
6. Pension Scheme: Pension plans are offered by mutual funds & insurance companies. However, recently introduced New Pension Scheme beats these plans. As per draft Direct Tax Code Bill, tax treatment for pension plan will be same as that for provident fund .  The investment amount will be deducted from total income, subject to overall limit and will also be exempt from tax at the time of withdrawal. They are good long term investment vehicle wherein your investment is locked till the age of 60 years. It invests part of the money in index funds and it can be actively or passively managed depending on the option you choose.

(to be continued…)

Comments deeply appreciated.

EPF or PPF? – Implications of EPF rate hike to 9.5%

The Central Board of Trustees, Employees Provident Fund (EPF) have recommended an interest rate of 9.5% on EPF for the financial year 2010-11 as against 8.5% which was prevalent for last five years.

The question is whether this rate will be sustainable? Most probably no.

The fund will be achieving return in the range of 8.5% from its corpus and the additional outgo of Rs. 1,600 crores on account of the rate hike of 1.0% will be met by ‘hidden surplus’ cash of Rs. 1,700 crores which was discovered after a comprehensive analysis of EPF scheme’s accounts since its inception. Hence this entire amount will vanish after this year’s interest payout.

Second, a news report says that Company-managed PF trusts, which are required to match the rate declared by EPF, are not happy with this rate hike, since they find it difficult to earn more than 8% and employers will have to contribute additional funds to maintain the interest payout.

Third, the trustees have not yet decided on investing part of the corpus in capital market, which will enable them to achieve higher returns.

All this signals that, unless the trustees agree to park part of the corpus in capital market, it will difficult for them to sustain interest rate of more than 8.5%. Thus this rate hike of 1% will be purely one-time on account of discovering the ‘hidden surplus’ cash.

Which fund gives better returns - EPF or PPF?

Public Provident Fund (PPF), in which any individual can invest up to Rs 70,000 p.a., gives tax-free return of 8%. Now comparing that with EPF tax-free return of 9.5% for this year, it makes sense for salaried employees to contribute more (beyond the mandatory 12% of Basic + DA) to their EPF rather than in PPF for this year. So start pumping more to your EPF through voluntary contribution for this year rather than investing in PPF.

One interesting thing to note is historically the rate of EPF has generally been more than PPF.

Interest Rate Comparison

The above chart shows that most of the time the difference is of 50 basis points where as in some years, the gap widens to as much as 150 basis points. One basis point is one-hundredth of a percentage point. This can make substantial difference in a long run. Hence it seems to be beneficial to invest in EPF more rather than in PPF for retirement savings.  Here retirement savings is important, since tenure of EPF is till retirement, whereas tenure of PPF is for 15 years.

In other announcements, the Trustees have decided to hike the benefit under Deposit Linked Insurance Scheme from present maximum limit of Rs. 1,00,000 to Rs. 1,30,000. This is payable to family of employees who die while in service. It will be calculated at 20 times average monthly wages drawn in preceding 12 months, subject to the cap of Rs. 1,30,000. 

The trustees have also decided to close “inoperative accounts” (no activity in preceding 36 months) and no interest would be credited to such accounts. The number of such accounts is approx. 3 crores.