- Insurance, gold or other assets cannot protect you against emergencies. You need a dedicated fund
- The ability to encash it quickly is the primary quality you should look for while choosing these investments
- Returns and tax efficiency don’t matter
- Stick to breakable FDs with top banks
- 9 months’ expenses are good, but may need tweaks for certain situations
One of the intriguing things about Indian Union Budget presentations is that tweaks to the tax laws that get just a half-a-minute mention in the budget speech often pack a big punch for taxpayers. This year, the move that fits this description is the Centre’s decision to offer a new friendlier tax regime to personal income tax payers, provided they are willing to give up a bunch of the exemptions that they currently enjoy on their savings and investments.
If you opt for the new regime in FY21, the axe will fall on all your tax saving investments under section 80C, section 80CCC, section 80CCD (1 and 1B), section 80D, section 80DD, section 80DDB, section 80EEA, section 80EEB and section 80G.
Folks who use the disallowed deductions to the hilt may be may be inclined to ignore this alphabet soup and stay with the old tax regime, as calculations show that they may pay more tax under the new regime.
But what of those who don’t use these deductions, or who don’t have any savings to park in tax saving instruments? They may be quite keen to hop on to the new regime with lower rates.
But does that mean all those investment instruments under section 80C are unattractive? Do they stand on their own merit even without tax breaks? Here’s taking stock.
Post office deposits
Today, initial amounts invested in the five-year term National Savings Time Deposit and the Senior Citizens Savings Scheme count as tax saving instruments under section 80C, while the interest you receive from them is taxable. The interest rates on both these deposits are reset at the beginning of each quarter.
For the present January 1 to March 31 2020 quarter, the 5-year national savings time deposit offers 7.7% per annum. Given that post office schemes are safer than bank deposits, the deposit remains superior to five-year deposits with leading banks such as SBI, ICICI Bank and HDFC Bank which offer 6.10 to 6.40%. But given that rates are close to the bottom of this cycle, investors can go in for 1-year time deposits with the post office that offer 6.9%, to capitalise on a spike later.
Even without 80C, the SCSS continues to ace five-year bank deposits for senior citizens which are at 6.75 to 6.90% at leading banks with its 8.6 per cent interest for five years. Given that it may be a long time before other options catch up with the SCSS on rates, this scheme still makes sense for seniors to lock into for 5 years.
Bank tax saving deposits
Tax saving term deposits from banks, usually available for 5 to 10-year terms are eligible for section 80C deductions currently. Once you remove this tax break, these deposits are unattractive. Leading banks only offer 6.1-6.4% for ordinary folk and 6.6-6.9% for senior citizens. Locking in for 5 years doesn’t make sense today, given that a year or so ahead, you may get to earn higher rates both from small savings schemes and from the leading banks with less risk.
The withdrawal of 80C will do away with the tax exemption both on your initial investment and the interest accumulated on NSC. Even without tax breaks though, the current 7.9% per annum interest on NSC is attractive for a government-backed instrument, compared to bank deposits that offer less. The scheme remains a good option in which to lock in your money for 5 years and to park debt allocations from your long-term portfolio.
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The removal of 80C exemptions on upfront payments on immediate annuity plans do not materially change the rationale for buying or not buying these schemes, given that the upfront payments will be far higher than Rs.1.5 lakh to set up a decent annuity.
Life & Health insurance
There are four classes of life insurance products that currently earn tax breaks under section 80C – premiums paid towards life insurance policies, upfront payments towards immediate annuities, premiums on deferred annuity and pension plans and contributions to ULIPs (subject to conditions on sum assured).
Tax breaks or no tax breaks, there’s an absolute need for every income-earner with dependents to invest in a pure term plan with a sufficient sum assured. With tax breaks no longer a consideration, investors should try to maximise their term cover to ensure that it adequately takes care of the loss of their income, their outstanding liabilities and the financial goals of their dependents, in the event of their passing.
The removal of 80C exemptions on upfront payments on immediate annuity plans do not materially change the rationale for buying or not buying these schemes, given that the upfront payments will be far higher than Rs.1.5 lakh to set up a decent annuity. Despite being plans that offer low, fully taxable returns (5-6 per cent at the most), they remain good products for non-savvy investors who seek absolute predictability of income. Lower slab rates under the new regime may also lift the post-tax income from these plans.
But two classes of insurance products could be rendered distinctly unattractive if tax benefits on the premiums are removed. Deferred annuity and pension plans of insurers typically require you to commit to fixed premium payments for multiple years and return it to you in the form of a regular pension payout once you retire. The high cost structures and the focus on ‘safety first’ in such plans usually makes for sub-optimal returns barely matching inflation. The withdrawal of 80C benefits just offers another reason to stay off these plans.
Regulatory curbs on their expenses have made the present-day ULIP more attractive than their counterparts in the past. Some of the well-run ones that you can buy online offer good competition to some categories of actively managed equity funds on costs and performance. But ULIPs still remain less investor-friendly products than equity mutual funds, on account of the compulsory bundling of the insurance component, lack of transparent benchmarking to markets or peers.
Though the new tax regime will entail foregoing substantial tax breaks on the premiums you pay towards health cover for yourself and your family under section 80D, health insurance remains a must-have in your portfolio. Ensure you renew and regularly top up your older health policies even with no tax breaks. Newbie investors just joining the workforce need to buy health insurance on priority, even before life insurance, to avoid a dent to their savings or interrupted income from unforeseen illness.
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But it may be best not to lock up all your debt allocations for retirement in EPF/PPF or up your contribution, given their lack of liquidity, fluidity of returns and now, the uncertainty about tax breaks.
Employees Provident Fund and Public Provident Fund
EPF/PPF are staples for most salaried and self-employed folks looking to build a retirement corpus. Today, both schemes enjoy an EEE status where your initial contributions are exempt under 80C upto Rs 1.5 lakh and the interest received and final maturity proceeds are exempt too. Opting for the new tax regime will need you to give up on the first E (on principal) while retaining the other two Es (interest and final pay outs).
The interest rate on the EPF is declared by the Centre every year. Lately, the scheme (8.55-8.65% interest) has offered an island of high returns in a falling rate scenario. However, the main issue with the scheme is the lack of visibility on whether its current high rates are sustainable.
The PPF interest rate is reset every quarter too, with the rate now at 7.9%. While this is attractive, there’s a catch. Unlike other post office schemes, the PPF does not allow you to lock into the prevailing interest rates for the entire tenure of the scheme. So if the Centre were to cut rates next quarter or after that, those new rates will apply to your entire PPF balance. This ‘floating’ nature of PPF returns reduces visibility of returns. The scheme’s 15 year lock in period (only partial withdrawal allowed with complex conditions) also bar early exit if you’re unhappy with the rates or tax treatment in future.
If you already have EPF/PPF accounts, there’s no reason to stop contributing to them. But it may be best not to lock up all your debt allocations for retirement in EPF/PPF or up your contribution, given their lack of liquidity, fluidity of returns and now, the uncertainty about tax breaks.
For folks starting out with a clean slate and don’t have access to EPF from their employer, the 7.75% GOI Savings Bond offers a good alternative to the PPF. The interest income here is taxable (unlike PPF), but you are shielded from rate volatility as you can lock into 7.75 per cent for the next seven years and go with a simpler structure. They can use a combination of this with debt funds.
Debt mutual funds investing in high quality bonds and 10-year constant maturity g-sec funds offer good supplements to PPF/EPF for your retirement savings, though, of course, they are riskier and will be taxed as long-term capital gain with indexation.
National Pension System
Under the new regime, tax exemptions on employees’ contributions to the NPS under section 80C and 8CCD (1B) will go (only the employer’s contribution to corporate NPS will be exempt). This substantially reduces the attractiveness of NPS.
In contrast to the EPF or PPF, the market-linked NPS does not enjoy a EEE status even now; it is best described as ETT. Only 60% of the final withdrawal from the scheme (both accumulated returns and principal) are exempt from tax, while 40% has to mandatorily go to purchasing annuities. The income from annuities is taxed at the slab rate. So, under the new regime, the NPS’ ETT status is likely to change to TTT!
While the change in tax structure does not detract from the NPS’ pluses such as low costs, flexible allocations, the ability to do tax-free switches and the ability to generate inflation-plus returns from market investments, NPS features such as restrictive withdrawal rules and the compulsion to buy low-return annuities at maturity render it unattractive.
At this juncture, it appears that index funds and direct plans of high-quality debt are options with less complexity. However, we will come up with an analysis-driven suggestion on if and how NPS can be part of your portfolio.
Without an 80C sweetener, there’s no particular reason for investors to take their equity exposures through ELSS funds which typically have vague mandates. A judicious mix of index or multicap funds would be a better way to invest towards long-term financial goals.
You can also use this retirement calculator to understand how much corpus you need to create before you retire and how to plan for it.
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