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Tax Planning for Retirees

N.Chandrasekaran Faculty Advisor

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Session Outline• Effect of inflation on our standard of living.• Scope available to protect income streams from

inflation.• Effect of income tax on residual funds to meet the

standard of living.• Terminal benefits that are tax free • Investment avenues for the terminal benefits.• Saving tax through Tax Planning

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We will start with effect of inflation on our standard of living after retirement

• The present WPI inflation is 5.7%. Let us assume that it comes down to 5% after the elections. Let us assume you are starting with a pension of Rs. 20000/- per month. i.e. Rs.240000/- per annum. When inflation is 5% per annum, after a period of 12 years, you will need Rs. 480000/- i.e. Rs. 40000/- per month to maintain your present standard of living. The formula for arriving at this number is given in the next slide.

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The formula

Present salary times (1 + assumed inflation rate)^number of years, e.g., 20000*(1.05)^12

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After retirement ….?

We will discuss how to keep up revenue sources so that a reasonable standard of living is maintained. We need to look at the sources that can keep up with inflation and also look at minimising the outflows in the form of taxes so that money is available to maintain the standard of living we are accustomed.

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Provident Fund• Payment from Provident Fund Section

10(12)]:• The accumulated balance due and becoming

payable to an employee participating in a Recognized Provident Fund is exempt to the extent provided in Rule 8 of Part A of the Fourth Schedule of the Income Tax Act.

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Provident Fund withdrawal not taxable if

• (i) if he has rendered continuous service with his employer for a period of five years or more, or (ii) if, though he has not rendered such continuous service, the service has been terminated by reason of the employees ill-health, or by the contraction or discontinuance of the employers business or other cause beyond the control of the employee.

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Gratuity• As per Section 10(10) of Income Tax Act, any

gratuity received to the extent it does not, exceed one- half month' s salary for each year of completed service, calculated on the basis of the average salary for the ten months immediately preceding the month in which any such event occurs, subject to a ceiling of Rs. 10 lacs. ( the limit was Rs. 3.5 lacs till 24.05.2010).

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Commutation of pension• As per Section 10(10A) of Income Tax Act, if the

employee receives gratuity, the commuted value of 1/3 of the pension is exempt, otherwise, the commuted value of ½ of the pension is exempt.

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Leave Encashment• As per Section 10(10AA) of Income Tax Act, if

the employee receives leave encashment, the exemption is to be limited to a maximum of 10 months of leave encashment, based on last 10 months average salary. This is further subject to a limit of Rs. 3,00,000/-.

How to be tax effective

AT the time of retirement, Bank deducts the tax as applicable and credits the terminal benefits. The various provisions of the Income Tax Act are discussed so that the amount received as terminal benefit can be tax effectively invested.

How to be tax effective

• Collecting your pension and provident fund money is work half-done. You have to plan meticulously to not only make your money yield returns that are higher than inflation but also minimise the amount you have to pay as tax

How to be tax effective

• Retirement does not mean the end of income. So, it is important to identify the sources of income on which you have to pay tax. Other than salary, tax is payable on income from property, that is, rent; capital gains (long and short term); and dividend and interest from equity and fixed-income investments

How to be tax effective

• Pension is also taxed as per the tax slabs for senior (60 years and above) and very senior citizens (80 years and above). Assuming you do not take up a job after retirement and your only sources of income are pension, rent and equity/fixed income investments, let's see how you can pay the least possible tax.

Tax Planning for retirees

• A person becomes senior citizen under Income Tax Act in the FY in which he attains age of 60 years even for one day. Once he attains 60 years, his status as senior citizen in that financial year, gives him some relief .

Tax Planning for retirees

To minimise tax

• In order to minimise tax, we can invest in products wherein either the yearly outflow or the maturity amount is taxfree.

To minimise tax

• Equity/equity mutual funds:Long term capital gains (on redemption after a year) from stocks and equity mutual funds are not taxed. However, experts say one must avoid over-exposure to stocks after retirement because they are risky. But given the need for generating returns higher than inflation, stocks may be a part of your portfolio.

How different asset classes have grown over 10 yrs

Asset classes over longer horizon

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Within different cities

SIP and one time investment

• SIPs mean investing with a fixed sum regularly regardless of the NAV or market level, investors automatically buy more units when the markets are low. This results in a lower average price, which translates to higher returns. SIP is a good way to invest at an average price over a period.

Tax Free Bonds

• Tax-free bonds:These are long-term fixed-income products with a lock-in of 10-15 years. The interest that you get is not taxed. However, if you sell the bonds on stock exchanges, where they are traded, you have to pay capital gains tax. E.g. National High Way Authority of India Tax free bond with 8.2% coupon but effective yield is 11.88%

Monthly Income Scheme

• Monthly income schemes (MIS):Post-office MIS are similar to bank fixed deposits, but with monthly interest payments. It is one of the most reliable sources of income for the retired. (good if your income is less than Rs. 2,50,000 p.a. or you are in the 10% tax bracket)

Monthly Income Plan of Mutual Funds

• one can invest in monthly income plans (MIPs) of mutual funds. MIPs invest in debt (majority) and equity. MIPs are more tax-efficient than MIS. Since stocks comprise less than 65 per cent of the portfolio, they are categorised as debt funds and taxed accordingly.

So, long-term capital gains are taxed at 10 per cent without indexation and 20 per cent with indexation..

Bank FD and form 15H

• If your total annual income is less than the income-tax threshold of Rs 2.5 lakh, you can avoid the tax deduction at source by submitting Form 15H to the Bank

Insurance Annuity

• The annuity amount is guaranteed for life. Annuity rates are usually benchmarked to medium or long-term government bonds.

For example, if you are 60 and want Rs 10,000 every month, you will have to pay the insurer Rs 13 lakh Investment in annuity qualifies for deduction under S 80 CCC of the Income Tax Act

Reverse Mortgage

• Reverse mortgage loan:If your retirement corpus is not enough to generate decent regular income to meet your post-retirement expenses, you can fall back on your house. You can take a loan against your home by mortgaging it with a lender (banks/housing finance companies) and receive a lump sum or periodic payments. Since the payments are in the form of a loan, they are exempt from tax

Short/Medium term investment

• Medium, short-termFor short- and medium-term investments, you can opt for fixed maturity plans (FMPs) of mutual funds, which are close-ended debt funds with tenures ranging from three months to three years. They are listed. Long term capital gains are taxed at10 per cent without indexation and 20 per cent with indexation.

Short/Medium term investment

• Often mutual funds launch FMPs with tenures of just over one year such as 370 days and 375 days. These help investors benefit from double indexation.

This means capital gains are adjusted for inflation twice, once in the year of investment and then in the year of maturity.

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Capital Charge Calculations

5. Subject long and short positions (short position is not allowed in India except in derivatives) in each time band to a 5% vertical disallowance designed to capture basis risk.

6. Carry forward the net positions in each time band for horizontal offsetting subject to disallowances.

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Duration:Weaknesses • Flat yield curve - same yield, irrespective of maturity

or product. Neglect of non-parallel shifts in yield curve across different

maturities - YIELD CURVE RISK. Asset and liability rates, within the same maturities, might not

change in the same proportion - BASIS RISK.• For large rate changes, duration underestimates

capital gains and overestimates capital losses, since price-yield relationship becomes nonlinear - CONVEXITY

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Capital Charge Calculations

5. Subject long and short positions (short position is not allowed in India except in derivatives) in each time band to a 5% vertical disallowance designed to capture basis risk.

6. Carry forward the net positions in each time band for horizontal offsetting subject to disallowances.

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Thank you !!!N.Chandrasekaran

Wish u all a happy, healthy and peaceful retired life.