29 Mar 2021

Beginning of a new financial year – a good time to review and plan your finances

We were hoping for life to be normal again. The roll out of Covid-19 vaccines sent some relief all across the world. However, the pandemic is raising its head again in India, with the number of daily cases as well as casualties going up again. While we are hopeful that things won’t reach the stage they did last year, one can never predict completely.

Last year, same time, people were caught off-guard with no room left to plan for an uncertain short-term and medium-term future. This time however, we will not have an excuse, if things go south, god forbid, from here again.

This is also a good time to revisit your personal finances in general, and your investment portfolio in particular, as we will soon be entering a new financial year. Let us understand why.

Salary Increases

This is probably the most plausible reason to revisit your financial planning at this stage. Most large corporate organisations schedule their annual increment and appraisal cycles around this time. If you are a lucky person getting a raise, don’t just spend all of it.

If you are in the armed forces, this is the time when your annual increment has either just happened or is about to happen.

Put some thought around how you plan to use it and whether that is the best possible option. Certainly, it is important to pamper yourself by some amount of indulgence for yourself and your family. But, make sure you put the raise to good use beyond the short-term.

Annual Tax Planning

As you must be observing right now or might have observed over the past few weeks, many people end up taking hasty decisions with respect to their tax planning towards the end of the financial year.

In spite of us harping on tax planning throughout the year, we still get numerous frantic calls in last 15 days of March on what to do to save tax under section 80C!

In fact, this should ideally be a good time to effectively plan for the next financial year. Not just that, if you plan efficiently, you will notice that tax planning for tax benefits for investments and insurance needs to be done only once in most cases. Let us explain.

Suppose you decide right now that in 2021-22, you will be disciplined with your annual tax planning. You will make the purchase of must-have financial products like health insurance and term life insurance, if so required by you, right in the beginning of the financial year, or in the initial few months. Then over the next few months you can invest the remainder of your 80C investments wisely in provident fund, public provident fund, or tax-saving mutual funds, as you choose.

Next year in March, you will then be worry free, unlike many of your peers. Then, a major part of your tax-saving investments for the year 2022-23 will automatically align with your payments in the early part of the financial year. This takes away the burden of last-minute planning and removes the errors that come in with last minute execution of hasty decisions.

Portfolio Rebalancing and Medium-Term Tax Planning

People who already have an investment portfolio might find this to be a good opportunity to analyse the performance of the portfolio and make adjustments to fine-tune it. While portfolio rebalancing should not wait for the change of a financial year, this time is helpful in a different way.

Suppose you have a financial goal coming up in the next year or two. You have been planning for this goal for a few years now and have been investing the savings for the same in equity mutual funds. This is the perfect time for you to evaluate the investment vis-à-vis the goal and start moving that amount from the equity funds to either debt funds or to your savings account. The reason being that if you make the withdrawal at the last minute without planning, your gains might be taxed at a higher rate for the long-term capital gains.

Instead, if you make withdrawals every year over the next couple of years, you can plan in a way that your returns are within the permitted range of tax-free capital gains. Not just tax efficiency, this will also shield your upcoming financial goals from market volatility.

Financial planning is not just about planning, but also calls for discipline in decision making as well as in implementation of those decisions. The beginning of the financial year is a good time to start with an efficient plan. The most crucial aspect of this journey is timely rebalancing of portfolio to ensure tax-efficiency as well as to meet financial goals timely.

26 Mar 2021
How to handle your DSOPF contributions now?

How to handle your DSOPF contributions now?

Please refer to our article: https://humfauji.in/the-provident-fund-shell-shock-what-to-do-now/

What is the latest update on it?

Finance minister Nirmala Sitharaman, on 23rd March 2021, increased the yearly contribution tax-free limit to Rs 5 Lakhs (from Rs 2.5 Lakhs announced in the budget speech) in provident funds (PFs) where there is no employer contribution. Essentially it means that if only the employees contribute to a PF, then the tax-free limit is Rs 5 Lakh for yearly contribution. DSOPF is one such PF where the employer (Govt) does not contribute anything to it, and hence, its tax-free contribution limit is also enhanced to 5 Lakhs now.

Does the tax limit for DSOPF also include contribution to PPF?

This aspect has not been clarified anywhere but considering the fact that the Finance Minister herself has chosen not to clarify it, probably the two would tend to be clubbed together through the PAN linkage. However, that is just our guesswork and may not b correct.

So, should you restrict your DSOPF contribution now from 1st April 2021 onwards?

  1. Before we discuss what to do now, we would like to bring out a few points for everybody affected to consider:-
    7.1% per annum tax-free interest is a good rate of interest to earn and that too with Govt guarantee, if you are looking for complete safety. DSOPF up to Rs 40,000 per month (Rs 41,666 to be more precise) would be good for the ‘fully-safety’ conscious.
  2. What about more than Rs 40,000 per month? Since most of the serving armed forces officers are in the 30% taxable bracket, after-tax returns on DSOPF then come out to be less than 5%, which is definitely not a good return to get on your life-time savings.
  3. Please remember that when you invest only in DSOPF kind of instruments, you are maintaining yourself just above the inflation mark – something like having your nose just above water level in a deep ocean! If you do not ‘venture out a bit’, you are making your money run very fast on a treadmill – it seems to be doing great till you get down from the treadmill and find that you’re just standing where you started from, having really gone nowhere!
  4. When we consider full safety while investing, then we also agree to accepting low returns on our investments. Look at the graph below:
  5. If some amount of ‘venturing out’ is to be done, what is the right way to go about? Please do consider equity investing, ie, the stock markets. They may seem volatile to many but remember that Equity is the ONLY investment class that will beat inflation and keep your nose well above the water. If you are serving (and that’s why we’re discussing DSOPF here!), you are comparatively young and hence, should not ignore equity investing. If you can choose direct stocks yourself (very few can, though!), go ahead. Otherwise, equity mutual funds (MFs) would be the best way to go about it.

 

How much in DSOPF and how much in Equity then?

We see two distinct cases here:-

  1. First case is where officers are contributing much in excess of Rs 40,000 (we take a case where the officer is contributing Rs 75,000 per month). They would generally be older officers and believe that one should keep the money safe all the time. For 75,000 per month, ie, Rs 9 Lakhs per year, contribution, Rs 5 Lakhs earn 7.1% while 4 Lakhs earns 4.88% after-tax, making it an average of 6.11%. With inflation in the 6-6.5% range right now, the head is sometimes out of deep water and sometimes below it!
    So, what to do? We suggest 5 Lakh in DSOPF and 4 Lakhs per year in Equity MFs. The latter should be done with a minimum 5-year perspective where there will be volatilities but end effect will be a comfortable very tax-efficient return. Volatilities mean you could see markets dip, sometime even below your cost price – but then they are paper losses and since time immemorial, equities have always performed in the long run.
    If the time perspective is shorter, then hybrid kind of funds can be gone ahead with. Also, consult a good financial planner if you’re not confident of handling this yourself.
  2. Second case is where the contribution capability is less than or around Rs 40,000 per month.
    If the aim is to remain absolutely safe and low returns are acceptable, then DSOPF should be the way to go. If one has a long-time frame and ready to accept volatility in the short term, a 50:50 split of the investible surplus between DSOPF and equity would be a good measure to go ahead with. Our suggestion again is to ‘venture out’ and not let your money earn sub-optimal returns. Investible surplus incidentally is: Gross Income – Salary Deductions – Regular Expenses – Loan payments – Tax.

Conclusion

The tax on DSOPF gives one a chance to break away from the DSOPF mindset which is so much engrained amongst the armed forces officers – all eggs in one basket can never be a good investing strategy.

If you are convinced about equity as an asset class, do go into it in a systematic manner with a long-term perspective, unmindful of mid-term volatilities.

22 Mar 2021

Time is Running out for Saving Tax under 80C section for this financial year

The Financial Year 2020-21 is just about to end in a few days. This year has been quite different for all of us.

In terms of financial planning and investments, the government had allowed us to invest for the previous financial year (2019-20) for several months into this financial year. Hence, it is a good time to remind that the extension given for FY2019-20 was a one-off event, and might not be repeated again.

It is crucial to remember that March 2020 was a wash-out in terms of financial activity due to the panic that set in due to the Covid-19 pandemic.

Tax Saving Provisions

So today we are here to just remind you about the tax-saving investments you need to make for the current financial year. This is mainly for those individuals who have chosen to remain under the old income tax regime. Accordingly, they have the window of investing up to Rs 1.5 lakhs under Section 80C of the Income Tax Act and up to Rs 1 lakh spending under Section 80D (medical insurance) of the tax laws.

What is Section 80C? This section gives you tax benefit for total investments up to Rs 1.5 Lakhs made in PF (EPF, PPF, DSOPF), Tax Saving Mutual Fund Schemes (ELSS), Insurance policies including AGIF/NGIS/AFGIS, tuition fee for your children, principal part of home loan payment, SCSS, NSC etc.

Not been able to do it or only done it partially? Let us see what should you do now?

We will first try to answer what not to choose.

Where not to invest?

In their hurry to make these investments in the last few days of the financial year, many people approach friends or relatives to figure out a solution to save some tax. Unfortunately, this hurry leads them towards poor products like buying insurance policies as a tax-saving-cum-investment avenue.

Subsequently, they realise that the investment is not in line with their requirements or they find themselves unable to pay the same high premium in the subsequent years for various reasons. This results in a significant loss, because only a small part of the amount paid in the first year gets recovered in most of the policies. Please make sure you do not buy an investment linked insurance policy at this stage at all.

Similarly, you could be told by someone to invest Rs 1 lakh in health insurance for yourself and your senior citizen parents to save tax of Rs 30,000. While this is better than the unsuitable life insurance policies highlighted above, be careful here too. Buying health insurance in a hurry is not a wise decision. Many factors need to be evaluated to get good health insurance. We won’t say don’t go for this, but instead, consult a financial advisor who will guide you on whether you need it at all and if yes, what is good for you.

Where to invest?

Now that you know the blacklist (for now), you can explore the remaining options depending on their suitability for you for now and for future.

The most preferred option at this stage could be an equity linked savings scheme (ELSS) which is the official name of tax-saving mutual funds. This is preferred because you will be investing in the equity markets with a 3-year lock-in period.

There is no compulsion of investing the same amount next year, so you are not stuck with what you choose this time. After 3 years, if you find it a good one to continue, it is your wish.

The ELSS not only gives you a tax benefit at the time of investing but also when you withdraw your amount after 3 years or later, the taxation of these schemes is very benign and user-friendly. Also, you get a chance for stock market related returns for as long as you want.

If you find this a good proposal, you can even start a SIP (Systematic Investment Plan) in it for Rs 12,500 per month from April 2021 onwards (totalling 12,500 X 12 = Rs 1.5 Lakh per year) so that the yearly hassles of rushing at the last minute are gone forever. However, one word of caution – please do a due diligence while selecting the right scheme. If you feel you are not adept at it, do not hesitate to take the help of a financial advisor.

The last and the safest option is probably going for investing the required amount in PPF. If you already have a PPF account, this is a better option. You do not need any major supervision to make this investment. Moreover, the returns are as guaranteed by the government. The only catch here is the lock-in period of 15 years in PPF. Hence, we said it is ideal for someone already having a PPF account. If you don’t already have a PPF account and typically are less than 55 years of age, you might want to consider having one. If arriving at that decision is taking time, choosing a good ELSS scheme might be the best choice left for you, which can be seamlessly executed now before the financial year ends.