Monday, February 4, 2013

Of Tax Savings and RGESS

I have seen that salaried people tend to invest in to tax saving schemes or instruments towards the last quarter of the financial year only. Logically, one should be setting aside some amount right from April each year and invest regularly and leave February and March to pay the taxman. I have seen people struggling with cash flows in the months of February and March and in the fight with the taxman, give up on the eligible investments. I am not an expert on taxation. However, what is clear is that if a sum, say, Rs.100,000 is invested in ‘eligible’ securities / investments then that amount could be deducted from the ‘taxable’ salary. In effect if your tax rate is 10% you save Rs.10,000 and so on. Obviously, the best returns come in when the tax rate is the highest. If the tax rate is 30%, then the incremental amount you are spending is Rs.70,000/-. In other words, for an investment that is available at Rs.100,000, you are in effect paying Rs.70,000/-. The newly introduced RGESS is a separate incentive for investing in to equities either directly (provided the stock is part of the 100 share index) or in specific mutual funds launched for this. Since this is once in a lifetime (as of now) exemption, it makes sense to use this only when your income hits the highest tax bracket. And unlike the 80C deductions, here only half of the amount is available as deduction. So, at a 30% tax bracket, it is like getting a 15% discount on the investment. Do not use up this exemption if you are not in the highest tax paying category. To my mind, the 15% discount for a good company stock is welcome provided the price is not too high. I would not use it now. And I would use the money to buy one or two stocks rather than put it in a mutual fund. In the 100 share index, there are some high quality multinational stocks like Nestle or HUL which can be bought. However, I would like to wait for better times (when the markets are a bit less expensive). Since it is going to be once in a lifetime opportunity, why rush in to it at the first year? The other thing about this RGESS is that it is not available if you have dabbled in equities in the past. Only the first timer gets this 15% discount on 50,000/- worth of stocks, ONCE in a lifetime. With the normal 80C, for the salaried, the room left may not be much after the PF contribution of the employer and some term life insurance premium. It is crazy that the GOI still allows deduction on ULIP contribution / endowment policy premiums etc. I would use the 80C fully by putting money in PPF. Life insurance is not a matter of tax deductions. A pure term policy depending on one’s financial situation should be a must. If you are wealthy or do not have any dependents, of course you do not need any life insurance. In India, tradability of life insurance term policies is not yet prevalent. Once it happens, then it is a great retirement investment. Simply buy a life policy with proceeds payable on death only. Sell it off when you are in your sunset years. Till then, life insurance as an investment, does not make any sense at all. All said, savings or investments should not be motivated by tax breaks alone. At some point, a rational government will / should take away tax breaks for investment in stock markets or similar speculative outflows. It is a matter of time before the taxation regime shifts to giving exemption or deduction at the point of investing and then taxing it on maturity or withdrawal. Such a proposal is already in the works. The other issue when we rush in to put money at the last moment is that we could end up locking up our money for unreasonable periods of time. Infrastructure bonds are one such instance. Why commit money for such a long period? There are so many shorter term options. Infrastructure bonds carry default risk, except for the fact that if government owned, the GOI will bail out the company. The only long term investment I would consider is a PPF account. Let us see what the new budget brings in terms of temptations for investments. Surely, the government would like to channelize some of the high savings we have in to spending on infrastructure or other assets for which the government does not seem to be able to find money. This is the last full budget before the next election ( unless we have an early election) so expect some goodies to come in for the salaried also.

No comments: