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.

SBI Bonds – one more opportunity to invest in a good instrument, but you must be really fast to pick it up!

SBI is back again with its second long tenure bond issue.  It had raised Rs. 1,000 crores in October 2010 and is now contemplating raising another Rs 2,000 crores with an option to retain over-subscription in Retail Category.  The bonds are issued in two categories – Retail & Non-retail and are available for the tenure of 10 years and 15 years.  The details of the bond issue are:

Series	Series 3 (Tenure 10 Years)		Series 4 (Tenure 15 Years)
Categories	Non-retail	Retail	Non-retail	Retail
Interest Rate	9.30%	9.75%	9.45%	9.95%
Call Option*	After 5 years		After 10 years

 *option for SBI to redeem the bonds

Issue Open Date: 21^st February 2011

Issue Close Date: 28^th February 2011

The closing date is irrelevant since going by the response the earlier issue of SBI bond received; it is most likely to get oversubscribed by end of the first day.   Hence investors willing to invest in this instrument should ensure that they submit their application forms on the first day itself.

This brings us to the procedure for subscribing these bonds.  These bonds are not available for online subscription and one need to visit SBI branch to collect and submit the application form.  Demat account is mandatory and these bonds will be listed on stock exchanges.  Hence it provides liquidity if someone wants to sell the bonds before completion of the tenure.  

Interest earned is taxable and if the bonds are sold on stock exchange, then they are also liable for capital gain tax.

How does it compare with other investment options (for retail investors)?

Though these bonds are unsecured, it carries AAA rating by CRISIL and is issued by one of the most trusted bank of India.  Hence an investor can be reasonably assured of the investments.  There are very few comparable options available for such a long tenure.  The table below gives comparison with other investment alternatives available for retail investors.

	SBI Retail Bonds	Bank Fixed Deposits	PPF	Infrastructure Bonds
Tenure	10 & 15 Years	Max 10 Years	15 Years (extendable)	Max 10 Years
Coupon Rate	9.75% – 9.95%	9.25%*	8%	8% – 8.30%
Tax	Taxable	Taxable	Tax-Free	Taxable
Limits	Rs. 5,00,000	No Limits	Rs. 70,000 p.a.	No limit

 *Kotak Mahindra Bank 10 Year Fixed Deposit

As can be seen, there is dearth of options for a person looking to invest for 15 years, except for PPF and this long tenure makes SBI bonds attractive. The retail bonds score over all forms of investments, except for PPF.  However, in case of PPF, there is an upper limit of Rs. 70,000 p.a. whereas, one can invest up to Rs. 5,00,000 in SBI Bonds. 

 

Hence for an investor who has exhausted his PPF limit for the current year, these bonds provide good long term investment opportunities.

Are you planning to invest in SBI Retail Bonds?  Were you lucky to get allotment in the earlier SBI Bond Issue?  Do share your comments with other readers below.

Endnote:  In case you have not yet participated in the survey of planning your tax-related investments, you can do so by clicking here.  The survey closes on Sunday, 20^th February 2011.  Thanks.

IDFC Infrastructure Bonds – Second Tranche to open from January 17, 2011

IDFC has come out with its second tranche of infrastructure bonds.  It will be open for subscription from January 17, 2011 till February 4, 2011.  The issue size is little below Rs. 3000 crores.  This time the options available are reduced to 2 as against the last time when 4 options were available.  This issue is similar to Series 1 and Series 2 of IDFC First Tranche Issue offering 8% interest rate for a period of 10 years with a buy back option at the end of 5 years.  Upto Rs 20,000 invested in these bonds is eligible for deduction while computing taxable income under section 80CCF of the Income Tax Act.  This is over and above Rs. 1,00,000 benefit available under section 80C.

To read more about these bonds, refer to the earlier posts on IDFC Bonds - First Trance Issue (here & here).  Please note that option of Series 3 and Series 4 is not available this time.

This is a good time to invest in tax-savings infrastructure bonds for those who have not yet made the investment in earlier issues of IDFC, IL&FS and L&T Infrastructure.   

To clear your doubts on the mystery of high tax-adjusted yields advertised by these companies, do read this article on whether such yields are really true?

Endnote:  This post is an update on the blog after nearly a month on no activity.  My apologizes for the same.  I will try to post one more article by the end of this month and regular posting will start from the month of February.  Thank you for bearing this and keep visiting this blog.

Infra bonds – Is the advertised yield really true?

Many people are aghast by the yield on Infra Bonds advertise by the companies and do not believe the same to be true.  In line with the basic principle of this blog - to make investing simpler - this article will try to clarify various doubts which many of my readers and investors have about these Infra Bonds.  Readers may also like to visit my earlier post on Infra Bonds.  

Reference here is made to L&T Infra Bonds since it is the only Infra bond which is open for subscription right now.  In no way it encourages or discourages any one to invest in the said bond.  Investment has to be made in line with the risk profile and investment objectives of an individual.

1. Is the tax-adjusted yield of 17.20% advertised really true (for Series III L&T Infra Bonds having 7.50% interest rate)?

This yield is based on certain assumptions:

a. You opt for the buyback option at the end of the 5 years.

b. You are able to take the benefit under Section 80 CCF of the Income Tax Act.

c.  You are in 30.90% tax bracket.  In case you are in lower tax bracket, the tax-adjusted yield will definitely be lower (further cover in detail below).

d.  It further assumes that you are investing the annual interest earned at the rate of 17.20% p.a.  Well I know this can never be achieved.  But this is the assumption behind the calculation.  In case, you assume that you are able to invest the annual interest earned at the rate of say 7.50%, then the tax-adjusted yield drops to 15.75%, which is still a good rate on investment.

2.  Why are they not adjusting the tax-adjusted yield of 17.20% for the tax which I will be required to pay on the interest earned? 

The interest earned on Infra Bonds is taxable in the hands of investor.  The tax-adjusted yield of 17.20% does not take into account any tax payable on annual interest received.  Adjusting for the same, the post-tax tax-adjusted yield comes to 14.23% for the above series bond.  Generally no one highlights post-tax tax-adjusted yield on investment.  Have you ever seen a bank saying that the interest rate on its 1 year Fixed Deposit is 5.4% p.a. (post tax) and not 7.75% (which is the interest rate)? 

Post-tax tax-adjusted yields for the entire series bond are as follows:

 

Series	Tax-adjusted yield	Post-tax tax-adjusted yield
Series 1	15.23%	12.16%
Series 2	13.59%	11.07%
Series 3	17.20%	14.23%
Series 4	15.75%	13.25%

The above yields are again for person in the tax bracket of 30.90%.  In case a person is in lower tax bracket, the yield will be different and lower from the above.  The table below provides details of post-tax tax-adjusted yields for entire series of L&T Infrastructure Bonds at different income tax slabs.

SERIES	Tax Slabs
	30.90%		20.60%		10.30%
	TAY	PT TAY	TAY	PT TAY	TAY	PT TAY
Series I	15.23%	12.16%	12.31%	10.45%	9.86%	9.00%
Series II	13.59%	11.07%	11.36%	9.71%	9.44%	8.63%
Series III	17.20%	14.23%	13.42%	11.62%	10.23%	9.40%
Series IV	15.75%	13.25%	12.58%	10.96%	9.86%	9.07%

TAY - Tax-adjusted yield

PT TAY - Post-tax tax-adjusted yield

3. Why the yield on Cumulative option (Series 2 or 4) less than the yield on Annual option (Series 1 or 3)?

Generally, all consultants advise us to go for cumulative option since it is more beneficial. If that being the case, then why the yield on cumulative option is less than the yield on annual option? This is due to the inherent assumption in calculating the yield on the investment. The calculations assume that in the annual option, you are able to re-invest the interest earned at the tax-adjusted yield rate (i.e. @ 15.23% for Series 1 and @ 17.20% for Series 3), whereas in the cumulative option you automatically reinvest any interest earned at the rate of 7.75% for Series 2 and at the rate of 7.50% option for Series 4.

Reinvesting at higher rates may be impossible, and hence the effective yield on Series 1 and Series 3 will be lower depending on how you re-invest the interest earned.  In case you do not invest at all, the yield will be further low.

4. If the re-investment is crucial, then in which option should I invest - Annual or Cumulative?

In case you are able to re-invest the funds at rate greater than interest rate offered (7.50% or 7.75% depending on the Series in which you invest in), you should opt for the annual option. In case, you are unable to do so, or you do not wish to go in for micro-management of investing the interest every year, you can opt for cumulative option.

5. How does it compare with other investment options?

Infra Bonds are attractive only due to one reason – the benefit they offer under section 80 CCF. Otherwise there are many other opportunities available which are more beneficial. Also you need to consider the security and liquidity issue before taking the final call. These bonds are not as secured as fixed deposits and the earliest you can liquidate is the first working day after the 5th year.

Given below is the comparison of L&T Infra bonds with SBI fixed deposit for 10 years, 10 years Government of India Bonds and L&T Finance Debentures which were issued for 10 years @ 10.40% and remaining period on which is approx 9 years and current price Rs. 1082 for Rs. 1000 bond. Remember that except for L&T Finance Debentures, others are not apple to apple comparison, but will help you to make investment decision (technically though L&T Finance Debenture is also not the accurate comparison!).

Tax Slabs	SBI FD	GOI Yield	L&T Finance Debentures	L&T Infra Bond Series II
0%	7.8%	8.1%	9.1%	13.6%
30.9%	5.4%	5.6%	6.0%	11.1%
20.6%	6.2%	6.5%	7.0%	9.7%
10.3%	7.0%	7.3%	8.1%	8.6%

As you can notice even at lowest tax bracket, the lowest of the yield of L&T Infra Bond is higher than Bank Fixed Deposit, Government of India Yield and L&T Finance Debentures.

To conclude, in case you have already exhausted the Section 80C benefits and you have additional funds to invest from your debt portfolio which you are planning to invest for long term, you should invest in these bonds to the extent of Rs. 20,000 only and not a rupee more.

Comments are deeply appreciated on the above.