Vaya Vandana Yojana is good for senior citizens

One of the good aspects of the current year budget has been the focus on senior citizens. While the tax slabs have not been changed, the exemption of interest income up to 50000 Rs is a good thing for all of them. Another benefit is the extension of Vaya Vandana Yojana for 2 years and changes in the terms.

The VVY was introduced last year and had interest payment up to 8.3 % annually on investment up to 7.5 lac Rs per senior citizen. Now it has been made 15 lacs maximum with flexibility of withdrawal in case of Medical emergencies. The monthly interest is 8 % and the annual yield goes to 8.3 %. You can buy it online or offline through LIC.

How should senior citizens use this? Well, you can invest up to 30 lacs in it now, for both you and your spouse. Along with the Senior citizen saving scheme, where you can potentially put another 30 lacs, this will give you a total interest income of 40000 Rs per month. While all of this is taxable, the tax incidence is practically zero for the couple.

This is something that all senior citizens should take advantage of. With a regular income of 40000 Rs per month assured, they can now think of putting the rest of their money in other mutual funds of different types to add to their income. In case they have a PPF account then there is also a possibility of withdrawing money from there in a tax free manner. With some intelligent structuring it will be quite possible to have an income of up to 80000 or so per month, with low tax incidence.

So, if you are a senior citizen and are looking at regular income, go for VVY. Yes, interest rates may rise but it will take a while to catch up to 8 % and a bird in hand is always worth more than two in the bush.

I will outline in the next post how a corpus of 1.5 crores including PPF can be structured for senior citizens to maximise income with low tax incidence.


Returns on Debt funds are more taxing now – A personal example

As I have written often in this blog, it is quite senseless to invest in FD for investors now, given the double whammy of low interest rates and returns being taxable at your slab rate. In general, investing in Debt funds makes sense – more so, if you are able to hold them for 3 years and get the benefits of indexation.

The above has been my strategy with FMP where the time to maturity is more than 3 years. While this has served me well in the past years, there are some changes in the scenario that all of us need to be aware of. With the lowering of inflation, the newly constituted Cost Inflation Index ( CII ) is less supportive of such a strategy. In fact, when I was doing an audit of my investments this month, I was shocked to notice that despite the indexation benefits, I would still be paying considerable taxes on this account. Now, I am all for paying the right taxes, but it is important to understand the impact.

Let me give you a specific example to see how things stand now:-

  • I had invested in HDFC FMP Series 28 on 21st November 2013
  • It was redeemed on 10th April, 2017
  • Initial purchase value was 3 lacs
  • Redeemed value in 2017 was 3.95 lacs
  • The indexed purchase price was 3.71 lacs as it got 4 years of indexation benefits.
  • The capital gains after indexation was 24000 Rs and tax thereon is 4800 Rs @ 20 %
  • In effect the absolute returns are 90000 in a period of 3 1/2 years.
  • Post tax CAGR is just above 7.5 %, it is 7.56 % to be exact.

Now while this still beats FD by a good distance as far as tax efficiency is concerned, the returns have come down from the past. Two years back it was possible to get CAGR of 8.5 % and more as taxation was minimal, if at all. It is also noteworthy that for FMP the rates are fixed at the start, so the ones starting now will have even lower returns.

What about other Debt funds? I have one from Franklin where the details are as below:-

  • Purchase date was 9th May, 2013 and purchase amount was 2 lacs
  • Current value is 2.92 lacs
  • Indexed value of purchase will be 2.47 lacs, so the capital gain is 45000 Rs
  • Tax on this will be 9000 Rs
  • Post tax CAGR will be nearly the same as the prior example.

Lesson from this for me and you as an investor? Debt funds are likely to give a post tax return of around 8 % or lower in the current context. Factor this into your calculations if you are using them to generate passive income, like I do. In simple terms if you need an income of about 8 lacs a year, you will need to put in 1 crore as capital investment for the debt funds.

It is still a good idea but we have to be conscious of how things change down the line.

My current Debt portfolio

In the past few posts I have written about my equity portfolio, both stocks and Mutual funds and also outlined why a debt portfolio is needed for all investors. In this post I wanted to take stock of my current debt portfolio. 

Before getting into the details of my holdings, let me try and summarise my reasons for having the debt portfolio in the first place:-

  1. It gives me passive income which takes care of my regular expenses along with the dividends I get from my equity investments.
  2. It allows me to let my equity investments grow for a longer time period, thereby increasing the chances of significant gains.
  3. It ensures that even if I need a large amount of money suddenly, I will not have to redeem my equity investments if the markets are having a bad time.

Having said that, I will now outline my current Debt portfolio. Note that I am not going to explain the rationale of these instruments – if you are interested, go through my blog posts and you will find enough material there explaining most instruments.

The major components of my Debt portfolio are as follows:-

  • Tax free bonds form about 13 % of my portfolio today. I get an interest of about 9 % from these bonds and they contribute nearly 25 % of my annual expenses ( without rent and travel ).
  • PPF forms about 27 % of my portfolio today. Both my wife and I have accounts in which we invest the maximum contribution allowed. As of now we do not withdraw from it and have no plans to do it for the next few years.
  • FMP plans and other debt funds form about 40 % of my portfolio today. I use the capital gains from FMP redemption for my expenses and reinvest the principal. As for the Debt funds I just let them grow, they can be useful for any sudden expenses.
  • Infrastructure Investment Funds and POMIS from post office form about 10 % of my portfolio. Income from these are normally used for my stock investments and they are also a backup as Emergency funds.
  • The last 10 % is in a couple of FD still going on, cash in our savings bank accounts and some amounts I have kept in my parent’s and children’s bank account.

You will note from here that the above is fairly simple to manage and the cash flows are automated into my account. Investing in PPF is an annual event, investing the principal amount from FMP redemption is probably 8-10 times in a year.

Apart from all of these I also have some investments in Hybrid funds. With the declining rate cycle it makes sense to do that and my focus on these have been there in the last 3 years or so. I will write about them in another post.

I hope this post will give you an idea as to how you can create your debt portfolio – make it hassle free and it will give you a great deal of peace in your mind.

Debt investments in 2018 – where and why?

In the last two posts I had written about two possible portfolios for MF investments. As readers will be aware the MF portfolio will normally cater to most of our life goals and also take care partly for retirement purpose. At the same time we will need a solid and robust Debt portfolio which gives a stable and strong foundation to our financial edifice. There are several posts in the blog where I have written extensively on the need of debt portfolio, what types of instruments are available and how you can make use of them. In this post I will not repeat those but give my thoughts on the instruments you can use.

Before we get down to the suggested instruments, it will be a good idea to look at the current landscape for the economic occurrences. In an interesting twist the bond yields have been going up and it may reach 7.5 % for the 10 year bonds before the budget. The reduction in interest rates seem to be over for now and, with the prospect of inflation coming down being unlikely, it is quite possible for the rates to rise later this year. Finally, this being the last full year of the present government, there will be a push on infrastructure and other social sector spending. This will normally increase government borrowing in the form of tax free bonds from NHAI and the like.

With the above as a backdrop, let us look at my recommendations now:-

  • For salaried people, continue with your PF or NPS as before. There is no real need to invest the extra 50000 in NPS unless you are fanatical about saving taxes.
  • For others not having the above options, you must have a PPF account. Yes, I know that the rates have dropped to 7.6 % this quarter but it is still the best debt instrument around. Rates will rise once the interest rate cycle turns.
  • If you already have a SSY account continue it, or have a daughter less than 10 years old, open one now. Benefits are similar to PPF with somewhat less flexibility but with a higher interest rate of 8.1 %.
  • Completely avoid FD’s as the rates and tax treatment are both terrible at this point of time. Senior citizens can put 15 lacs in SCSS if they are not having a high tax impact. The current rates of 8.3 % seem attractive.
  • In case bond yields continue to rise there may be a case of putting some amount in FMP. At current returns, this is not a great idea for pure debt FMP.
  • Look at alternative hybrid models if you are still interested in FMP – options can be Dual advantage funds or similar themes.
  • Certain types of Debt MF can give returns in the range of 9-9.5 % this year. If you can hold these for 3 years you will get the LTCG indexation benefits, which make it an attractive investment. Look at Dynamic bond funds for this purpose – most fund houses have them but I will recommend BSL or IDFC.
  • For investors having a shorter time frame look at Franklin Dynamic Accrual Bond.
  • You can also go for Ultra short term or Short term debt funds for 3 years.
  • Avoid long term funds in Debt space, especially the Long term Gilt funds.

I hope with the above guidelines you will be able to structure your debt investments for the year. Remember, debt is important – redeeming equity at the wrong times can be really detrimental to your overall financial portfolio.

I have also got a range of queries as to how people in retirement should look at deploying their resources for optimal returns. Will try to address it in the next post.

How I plan to use my PPF account

With the rate reduction in PPF scheme and the knowledge that it is going to be aligned to market rates every quarter from now on, is it still a good idea to have it in my portfolio? In my audit of investments for last FY that was the main question I was faced with regarding my PPF investments.

Now in terms of personal finance every issue and decision is contextual and the situation of the individual makes all the difference. In my case I have a PPF account since 1994 and my wife has started a second account in 2013 after the first one was matured in 2004. Some details of these accounts are as follows:-

  • My present maturity is in 2019 April and current balance is about 20 % of our total debt portfolio.
  • My wife’s account will mature in 2028 and currently is about 3.5 % of our debt portfolio.
  • Contribution of 1.5 lacs is made every year in the first week of April to both accounts.

Given the tax treatment of PPF at EEE, I see no reason to stop my investments in it even though the interest rates have reduced to 7.8% currently. I think the returns on PPF will go down further to about 7.5% or so, but even that is not a bad rate for an EEE instrument. In the coming years the interest rate cycle is very likely to turn around and at that point in time, PPF will immediately get benefited as the rates are market linked now.

With the investment decision taken, the next issue is how to use the money in the account. So far I have not withdrawn any money out of my account since 1994 and do not plan to do so till the current maturity in April 2019. The same goes for my wife’s account. Her first PPF maturity amount had helped us greatly to boost the down payment that we were able to make for our apartment in Chennai.

So after a lot of thought these are the conclusions I have come to:-

  • Continue my account after 2019 for another 5 years while being open to withdrawals for any emergency post 2019.
  • Assuming that my daughter gets married in the period beyond 2019, such withdrawals can fund her marriage expenses to the extent needed. Even though I have investments in equity for it, a hedge against market crashes is prudent.
  • Withdrawals can also be used for discretionary purposes such as replacement of white goods, vacations outside India etc.
  • As I will normally not need the PPF account withdrawals for my regular expenditure at least till 2024 or so, in the absence of any of the above the money will simply grow.
  • As far as my wife’s PPF account goes it will grow to 40 lacs plus by 2028. At this point if the returns are decent we will continue it. Note that we can withdraw 24 lacs in the subsequent 5 years from her account.
  • Assuming that I can withdraw about twice that amount from my account in 5 years, the total withdrawn amount in 5 years will be 72 lacs. This can be used for a variety of purposes as explained earlier.

How will I fund the 3 lacs per year? As of now, I am doing it from my Consultancy income and hope to do so for the next 5-6 years. Beyond that or in case the income is insufficient in a year, I have plans to fund it through the redemption of debt funds such as FMP etc that keep happening every year.

In the end what does the PPF investment mean to me? Well, it is something from which I can withdraw any time I have an exceptional expense whether due to an emergency or due to an indulgence that we need to do. It also gives me the cushion of not having to redeem my equity investments for fulfilling a goal, when the markets are in a bad situation.

In short it contributes a great deal to my peace of mind.

Need regular income? There are better options to FD

In the last post I had said that we will need to look at a category separately, those who are retired or otherwise and seek regular income for their expenses. Most of these people keep their money in Bank FD’s. Some look at slightly riskier options of corporate FD or NCD in order to earn a little more interest. In this post I will examine options such people have in looking at other instruments.

Now, to give some structure to the discussions let us assume the investor will need 6 lacs per year for his expenses, given that he has a home to stay in and his children being settled financially. If he has 1 crore out of his retirement proceeds or other assets, one option will be to put it in FD. As a senior citizen he will probably get a rate of 7.5 % per year today. So he gets 7.5 lacs in a year which will be good enough for his expenses. As a senior citizen his taxes on this will be 60000 Rs, can also get reduced if he invests in 80 C instruments, medical insurance etc.

So, if this seems to work, why should they just not do it? Firstly, there is no guarantee that the interest rates will not go down further. Secondly, inflation is always going to be a factor and even with a 6 % inflation the costs will double in 12 years time. Thirdly, as no one can predict the life span it will always be better to have some growth factored into your portfolio. In the FD scenario there is absolutely no growth. Fourthly, with increasing expenses you will soon be eating into the capital and may reach a situation that you run out of money long before your passing away.

Let me outline some alternatives with the pros and cons that the investor can look at. I will not go into too much theory here, those are all available in my blog or in the public domain. 

  • Keep the money in the dividend option of MIP funds. These funds mostly give a monthly dividend which will be tax free in your hands. However, there is a Dividend Distribution Tax the fund house has to pay.
  • You can also use the Growth option of MIP and redeem to the extent you need money every month. It will be better to do this after your investment has crossed 3 years as you can get the benefit of LTCG indexation.
  • If you have planned earlier then set up 3 year FMP. As they mature you can use the capital gains for your regular expenses and reinvest the Principal amount in other FMP. With the rates coming down you may want to invest in dual advantage FMP to get incrementally better returns, though with some element of risk.
  • You can put your money in ICICI Balanced Advantage or similar funds which allow selection of dividend in a defined manner. At a rate of 9 % your returns will be adequate for your expenses and dividends are tax free in your hands. However, as the equity exposure is significant here, the element of risk is also high.
  • The above strategy can be also used with Equity Savings Funds, Dynamic Funds or even pure Equity funds as long as you are able to afford the risk.
  • Finally, you can of course try a combination of the above.

How do I invest myself ? Well, for several years now I have no Fixed income product except for Post Office MIS and that was done with a specific purpose in mind. My alternatives have been in FMP, Balanced funds, Gilt funds, MIP, Equity Savings Funds and so on.  For the debt space, I feel I have got a good balance between decent returns and good tax efficiency.

I will write in some details on these later on and also share a couple of real life case studies.

So what is the alternative to FD’s ?

In the last post I wrote about why FD as an investment is not at all a suitable one. It offers low returns and is clearly not tax efficient. The natural question therefore is, which are the investments to replace traditional bank FD? In this post I will try to answer the same.

Let us first look at why do people invest in FD. There can be many reasons but 3 of them are the most common ones:-

  1. Many people simply do not know of any options for savings and think this is a safe way which will also earn some returns.
  2. Some investors look at FDs as a good place for an Emergency fund and also for any goal that may be coming up in the next 1-5 years.
  3. Retired people and others who want a regular source of income keep their money invested in FD for the longer term.

In this post I will deal with the first two as the last one is more complex in nature and deserves to be dealt with separately.

For the first category of people, if they are able to keep the money for long term, my recommendation will be PPF. The returns here are more than FD today and they are tax free. Moreover you get 80 C benefits with PPF, so if you have not exhausted your 1.5 lac limit through other means, this is a great benefit. Also, though PPF is for a 15 year term, you can make withdrawals after 6 years. Finally, if you start early, this will be a great backup to your MF redemption, in the years which are not good for equity.

What if you do not want a long term product such as PPF? Well, one option can be Arbitrage funds which will probably give you returns of around 7 %. While this is pretty much the same as FD, the tax treatment is much better as you will not be paying any taxes on the capital gains after one year. You can therefore park your money here and redeem it in a tax free manner for any needs in an ongoing basis. Arbitrage funds are also quite risk free as far as your capital is concerned, unlike equity funds.

Regular Debt funds or FMP, MIP etc will work if your time frame is at least 3 years. This is the time you need to keep your money to get indexation benefits for LTCG. Note here that with the Cost Inflation Index ( CII ) being dampened due to lower inflation numbers, you will still need to pay some taxes but this would be on a much lower scale. Also, as the interest rates will go up, Debt funds and MIP are likely to have a lower return. We are pretty much at the bottom of the cycle and rates will go up in the next 1-2 years. Finally MIP will do very well if equities are doing well but therein lies the risk too.

In conclusion for the first category of people, use the following strategies:-

  • If you are OK with a little risk go for MIP and Debt funds.
  • If you are having lower risk taking ability but can wait 3 years or more go for FMP. Here too you can look at Dual Advantage FMP if some risk is all right.
  • In case you do not have 3 years and are looking at moderate but steady returns, look at Arbitrage funds.
  • If you just want to save and are not going to need the money for long, look at PPF.

What about category 2 people? Many financial planners will advise you to withdraw from equity and part the money in debt some 3 years before your goal etc. I have never found any sense in this as you might really be losing out on growth by such actions. At the same time being purely in equity is not a good idea either. You need to take some middle path which balances the needs of both growth and safety.

  • Higher risk takers can try Equity Savings Funds or Balanced Funds.
  • Moderate risk takers can try MIP, Dual Advantage FMP, Debt funds
  • Risk averse investors can try FMP, Liquid funds, Arbitrage funds

Note here that the higher risk options are more suited to 3 years plus time frame.

So, there you have it. Now that you know what to do with your money which is in bank FD’s, go ahead and stop those. You will soon thank me for having written this post !!