The illusion of children-specific products

If you love your children, buy our product. As product pitches go, it’s simple, direct and manipulative. Unfortunately, it’s also far too widely used. While I have nothing to say on the merits or otherwise of health drinks or educational aids or even cars (!) that use this tack, financial products are another matter. Products that use the children ploy to sell have a long history in India. Insurance, as well as mutual fund products that have the words ‘child’ or children in their name, have been around for so long that many people assume that there is a specific class of products that provide some unique advantage to their children’s future that other products do not.

So much so, that at Value Research, we get a substantial flow of emails from worried parents who are looking for the best possible ‘child plan.’ With years of background exposure to the phrase, they just assume that somewhat like a tax plan, a child plan is an integral part of personal finance. Well, guess what, ‘child plan’ is actually not a financial term all but a marketing one.

There’s nothing distinctive about them. For example, one of the largest ‘child’ mutual funds was for years just a vanilla balanced fund of mediocre performance. The pitch was that you should invest in it and use the money for your kids’ college fees. However, the returns that such funds produce are not made up of money that is specially designed for paying college fees—it’s just normal money. However, if the loving parents had chosen better performing funds, they would have more of it and that would probably be some actual help.

Insurance products too play a similar trick. There’s nothing distinctive about the products themselves. You can pitch a product by saying that if you die then kids’ college fees can be paid out of the benefits, but so could those from any insurance policy.

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Best Gift for Your Child is a Life Cover

If not you, who?

young motherThere’s something magical about seeing your child for the first time. We treasure the moment because it soon transforms into an eternity of diaper changes and feedings. This is followed by school-runs, home-work and fights on the playground. We do our best, muddle along and if all goes well, our kids settle into good jobs and happy families of their own. The keyword here, of course, is ‘if.’

The hard-truth about children is that they cost money. Their up-keep, schooling and holidays cost money, as do the tuition classes, sports camps and visits to the local theme park. Your existence is their only source of income. You may have family who will take care of them on your death but banking on this is not a rational strategy. The generosity of an uncle or aunt is simply no substitute for the support that a parent provides. And what if the uncle or grandparent in question simply can’t afford it?

So how much does term life insurance cost? The triviality of the figure is mind-boggling. A typical one crore cover for a 30 year old male non-smoker can cost less than Rs 1000 per month. This is the price of an hour of badminton coaching or that dinner you had last week at an uppity restaurant. The figure does change with factors such as age and location but the magnitude of cover available under term life insurance is still enormous (and beats other types of life insurance hands down). The premiums for it are also tax deductible under Section 80C upto Rs 1.5 lakhs.

Double lock the door
We do not usually count loan recovery cases among our top 10 worries. As long as we are alive and have a job, EMIs are a pain but one we take care of. This can change dramatically on our death. A lender can come between your child and his future. If you’re a businessman, creditors can have the same effect on your estate. To this, there is protection available in the form of the Married Woman’s Property Act (MWP Act). Term Life Insurance policies bought under this Act are held in trust for your wife and/or children. Money paid out under them cannot be seized by creditors. Making sure your policy is covered by the Act is not difficult. If you are buying insurance online, it can be as easy as ticking a box. However, make sure that the Act applies to your policy before you buy it. You cannot add it subsequently.

How to buy
Buy term life insurance online from the insurer’s website or from a financial planner.

Credit:  Valueserachonline

How to disclose capital gains in your income tax return

Profits or gains arising from transfer of a capital asset such as property, gold, shares and bonds are considered capital gains and taxed under the income head “capital gains”. Graphic: Jayachandran/Mint

Profits or gains arising from transfer of a capital asset such as property, gold, shares and bonds are considered capital gains and taxed under the income head “capital gains”. 

While filing your income tax return (ITR) for assessment year (AY) 2018-19, the deadline for which is 31 July, don’t just look at the Form 16 you get from your employer even if you are a salaried individual. Make sure you disclose gains or losses made from selling shares or redeeming mutual fund (MF) units or selling a property or jewelry.

Irrespective of the amount gained or lost, one must disclose capital gains or losses while filing ITR. Here is how you can calculate capital gains from different assets and how to disclose them while filing ITR.

Calculating capital gains

Profits or gains arising from the transfer of a capital asset such as property, gold, shares and bonds are considered capital gains and taxed under the income head “capital gains”. Such gains are of two types—short-term and long-term—depending on the period of holding. Capital gains are calculated by deducting the cost of acquiring the asset from its sale value. But the rules are different for different assets.

Real estate: Gains made from the transfer of immovable property (land, house, apartment) within two years of purchase are considered short-term capital gains (STCG); after two years, they become long-term capital gains (LTCG). The LTCG rate is 20% with indexation, while STCG is taxed at the slab rate.

To calculate LTCG, first calculate the indexed cost of acquisition “by multiplying the cost of acquisition with the notified cost inflation index (CII) for the year of sale and dividing this by CII of the year of purchase,” said Sandeep Sehgal, director-tax and regulatory, Ashok Maheshwary & Associates LLP, a chartered accountancy firm. But if the asset was bought before 2001, then you need to use the fair market value (FMV) as on 1 April 2001 and then calculate the indexed cost of acquisition. For instance, if the property was bought in 1995, you need to calculate the property’s FMV as on 1 April 2001 and then arrive at the cost of acquisition.

The rules are different for an inherited or gifted property. Here, the “cost of acquisition incurred by the previous owner and his or her period of holding is considered to compute gains,” said Sehgal.

Any expense necessary at the time of the asset’s acquisition or transfer can be added to the indexed cost of acquisition. For instance, stamp duty, registration fee, brokerage charges and legal fees.

However, you can avoid paying LTCG tax on property transfer or reduce the tax implication to some extent by reinvesting the capital gains into a residential property or specified infrastructure bonds, within a specified time period.

Shares and mutual funds: Gains from transfer of shares and equity oriented mutual funds within a year of purchase are considered STCG; after a year, they are considered LTCG. For the current AY 2018-19, STCG tax for such assets is 15%. Whereas LTCG from equity is exempt from tax.

But from next AY i.e. 2019-20, LTCG will be taxed. Because, the Finance Act, 2018 withdrew the exemption granted under Section 10(38). A new section, 112A, was introduced with effect from 1 April 2018. “It provides that LTCG from equity exceeding ₹1 lakh per year shall be taxable at the rate of 10% (plus applicable surcharge and cess) without any indexation benefit,” said Taranpreet Singh, partner, TASS Advisors, a chartered accountancy firm. There is also a provision of grandfathering.

In case of short-term capital loss (STCL), it can be set off against other STCG. It can also be carried forward to subsequent financial years for set-off. Long-term capital loss (LTCL) are not allowed to be set off or carried forward.

Expenses incurred in transacting shares or equity mutual fund units can be claimed for deduction when calculating capital gains.

For debt-oriented funds, both holding period and tax implications are different. Gains made from selling debt-oriented fund units within 36 months of holding are considered STCG and taxed at the slab rate. “Sale of debt-oriented fund units shall trigger LTCG tax when the holding period is more than 36 months. The rate of tax is 20% (plus applicable surcharge and cess) with indexation benefit,” said Singh.

Gold and bonds: “Jewellery or bullion are chargeable to capital gains tax, irrespective of the method of acquisition—self-purchased, gifted or inherited,” said Sehgal. If sold before three years from the date of purchase, gains are considered STCG, else LTCG. STCG from sale of gold is taxed at the slab rate, and LTCG at 20% with indexation.

There are different rules for bonds depending on the issuer and other features. For instance, listed corporate bonds are considered short term if sold before one year from the date of purchase. STCG is taxed at slab rate. If such bonds are sold after a year, the gains are considered LTCG and taxed at the rate of 10% without indexation. Apart from these, specified tax-free bonds (listed or unlisted) are covered under Section 10(15) of the Income Tax Act and are exempt from tax.

Disclosing gains in ITR

Once you have figured out what your capital gains or losses are, the next step is to include them in your ITR form. There are different ITR forms based on the type and amount of income. “Individuals with income from salary and capital gains are required to fill ITR-2,” said Singh.

This AY 2018-19, you are required to put the details and break-up of each income in your return, including capital gains. “The requirements regarding capital gains in ITR-2 are extensive and depend upon the type of asset sold and period of holding, whether it is a long-term capital asset or a short-term capital asset. Generally, the details to be disclosed are the date of sale and purchase, purchase amount, sales consideration, type of asset, transfer expenses and so on. If the capital asset is a security, you need to furnish additional information like whether STT is paid or not, whether it’s listed or unlisted,” said Sehgal.

Apart from that, expenses claimed while calculating capital gains should also be mentioned clearly. For instance, “brokerage and other expenses in connection to transfer to compute the capital gain, also need to be mentioned,” said Singh.

Even if capital gains earned are tax-exempt, they need to be disclosed in the return. There is a separate space in the ITR to mention details of exempt incomes. “It is also advisable to disclose all kinds of exempt income, including exempt capital gains. Such exempt incomes are to be disclosed in Schedule EI,” said Sehgal.

Over the years, the tax department has become vigilant and tracks all transactions and compares them with the return filed by an individual. Misreporting or under-reporting income can be traced, and may result in penalty and fine. If you have transacted in capital assets or have any other type of income which you are unsure of how and where to disclose, take the help of chartered accountants or tax return preparers to help file your ITR.

Credit: Mint



Renting vs buying a house: Figures don’t lie

Last year discussions with friends centered around the rent versus buy decision. This year, hopes are fueled with conversations about purchasing that house given even lower prices. Has a drop in property prices made buying more lucrative than renting? Does economic logic today support buying rather than renting?

I stress on the term economic logic because reasoning based on personal preference has unmatched support in the society for buying property. Owning a property is etched in our tradition and possibly in many others. Personal preferences aside, whether you make an outright purchase or take a home loan, the economic logic does not support the buy option even today.

Do the math. Say you have just enough to buy a 3-BHK apartment. To the property price, add costs like stamp duty, registration and municipal taxes-an increase of about 8-10% to the total cost. Then, the cost of doing up interiors-it can be as little or as much as you like. In building complexes, there will be recurring monthly maintenance-more the amenities, higher the charges. If you opt to build your house, there are costs for the upkeep.

Now assess this against a rental property. Mumbai has a rental yield of 2.5-3%; your monthly rental comes to Rs 20,000-25,000 for a property worth Rs 1 crore. In Mumbai, the owner usually takes care of maintenance and structural repair costs. The lump sum you saved by not buying a house can be invested in equity mutual funds. Given an estimated annualised return of 12% (over periods of 10-20 years), at the end of 10 years even after deducting annual rentals (with an annual escalation of 7%) and, say, an initial deposit of Rs 5 lakh, you will have around Rs 2.6 crore. No taxes to pay, no interest repayment, no monthly maintenance. You get the drift.

Taking a loan? Consider this: for a 20-year housing loan for a Rs 1 crore principal at 8.5% per annum, you pay interest of around Rs 1.06 crore, more than the value of your loan. Plus, the costs and property taxes.

These figures are difficult to ignore. It’s low rental yields in large Indian cities compared to the rate of interest on loans that make renting economically more viable. Also, land prices have skyrocketed over the years, resulting in a disproportionately higher cost per square feet in certain locations. Yes if you are an outright buyer (no loan), you are looking at gains from capital value. But if you are living in that house, you may never sell it. Plus, real estate is not a liquid asset. Lastly, we are having this conversation because the pot of money is limited and needs efficient allocation to create future wealth. If you have an uncountable surplus, there is little merit in such tedious assessments.

People have seen property value increasing 10-12 times in 15 years or so, thanks to the real estate boom cycle from the mid- 1990s or thereabouts. That is an annualised return of 17-18%. Truth is you would have made 20-21% average annualised tax-free return with an equity diversified fund for the same 15-year period. The 20-year average annualised return would be around 17%.  We are not even touching upon lifestyle aspects of cutting back on expenses or being tied down to a job you don’t like just to pay interest; traveling long hours because you could only afford that house in that locality and so on.

There is pride in being an owner. Your own house will always come with a greater sense of achievement as compared to, say, your own mutual fund portfolio. But remove the rose-coloured glasses and you will find it’s simply a triumph of emotional bias over pure economic logic, at least for now, till the equation turns.

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Tax planning and SIPs

Many of us approach tax planning as a recurring headache that has to be got rid of somehow. As the end of the financial year approaches and the accountant asks for investment proofs, we tend to scramble for any tax-saving investments. Many of us even fall prey to unscrupulous salespeople, who peddle us some investment product not quite suited to our needs. Once we have unwittingly put our money into some investment, we feel the job is done. Later, we forget about the money.

Not planning for your income tax properly is a serious investment mistake. As the process described above is repeated over the years, your chances for wealth creation are diminished. Here is how. Let’s say you invest the entire tax-exempt amount of Rs1.5 lakh in a mutual fund every year for 40 years at 12 % rate of return. After 40 years, you will have Rs12.89 crore. You get this enormous sum without making any additional investments but just by carefully investing your tax-saving money. So by not taking your tax-saving investments seriously, you actually lose the opportunity to build wealth in a simple manner.

But what exactly stops us from making prudent tax-planning decisions? The devil lies in deferring the tax-planning activity to the last moment. The right way to plan for your taxes is to start investing at the beginning of a financial year, not when it is drawing to a close. By systematically investing in tax-saving plans, also called equity-linked savings schemes (ELSS), you can bring discipline to your approach.

Just pick one or two good tax-savers and start SIPs in them at the start of the financial year. You can even opt for the auto-deduction facility. With it, the specified amount gets debited from your bank account periodically and is invested in a fund. This does away with manual intervention and hence precludes missing out on your monthly investment.

Another benefit of SIPs is that they help you invest over the market cycle and hence you don’t catch a market peak. What does this mean? Let’s say you are suddenly reminded that there is something such as tax planning and you have to invest in the next two days to avail tax benefits. You quickly find an investment, say, a mutual fund. You invest Rs1.5 lakh in it in one go and feel happy that the job is over. But you don’t realise that the stock market was at its peak when you made that investment. As the stock market corrects, your investment goes into red. It takes many months or perhaps years to recoup your losses.

With SIPs, you could have avoided this. Since SIPs help you invest over the market cycle, you invest at both market highs and lows. This averages your cost. You automatically buy fewer units when the market is high and more when it’s low. A market downturn doesn’t hit you as much hard as it would have if you had invested a lump sum.

Properly investing your tax-saving money through SIPs kills two birds with one stone: you save the tax outgo and you build wealth. What else could be a better deal?

Credit: Valueresearchonline