Is it better to invest lump sum or
monthly SIP in mutual funds?
A lot of people ask me such questions – whether SIP (Systematic Investment Plan) is better than lump sum investing in mutual funds in India? Or whether lumpsum investing is better than mutual fund SIP?
Why I don’t
like these questions (are SIPs better
than lumpsum investments?) is because as usual, there is no one right
answer here.
There are
shades of grey and it isn’t exactly an ideal comparison.
People want
to simply compare SIP vs one time investment in mutual funds or just want to find
out which are top mutual funds for SIP in 2019 or best mutual funds for lump
sum investment in 2019 and what not. But there are no perfect answers or ready
lists that predict anything.
And let’s
look at it from a common-sense perspective.
Before even
getting into lump sum vs monthly investment debate, the decision to invest in
lump sum or SIP depends on whether one actually has enough investible surplus
that can be called as lumpsum!
Right?
If one doesn’t
even have this ‘lump sum’ then this question of SIP or lump sum in itself is
meaningless. It’s only when this ‘lumpsum’ is actually available that the
question holds any relevance.
And once
the lump sum is there, the next question should be whether investing in one go
is better or whether it’s wiser to spread that lump sum over a short period of
time, as there can be several best ways to invest a large sum of money in
mutual funds. Just because the lump sum is available doesn’t mean that the
money should be invested in one go. There are can various other tactics to
deploy it more efficiently.
But nevertheless, there are those who prefer SIP (and have SIP success stories to tell) and there are those who prefer lump sum investing.
And to be
honest, both methods work in different set of circumstances.
Let’s try
to do this comparison as objectively as possible.
SIP vs Lumpsum in Rising
(Bull) Markets
In a rising
market, your lumpsum investments in mutual funds will produce higher returns
than SIPs. That’s because the cost of purchase in a lumpsum investment in a
rising market would always be lower than the average cost of purchase in SIP, which
is spread out across higher and higher purchase prices for each SIP
installment.
Let’s take a
very simple hypothetical example to show this.
Suppose one investor invests Rs 5000 per month in a rising market for 12 months. While the other invests Rs 60,000 as lumpsum at the start itself. Both invest in mutual funds a total of Rs 60,000. Here is how it pans out over the next 12 months:
As can be
seen above, the average cost (average NAV) for the SIP investor in a rising
market is higher. And hence, the future hypothetical profit when sold later,
will be lower for the SIP than that of the lumpsum investor.
Now let’s
look at a falling market scenario.
SIP vs Lumpsum in Falling
(Bear) Markets
In a
falling market, the SIP investing would result in comparatively lower losses
than that in lump sum. And that is because the cost of purchase in a lumpsum
investment in a falling market would always be higher than the average cost of
purchase in SIP.
Here is how
it looks:
As can be
seen, the average cost for the SIP investor in a falling market is lower. And
hence, the future hypothetical profit when sold later, will be higher for the SIP
investor than it is for the lumpsum investor.
So
basically what is happening is that if the market grows continuously, then lump
sum investing gives higher returns whereas if it falls continuously, then SIP
investing is better (lesser losses than that of lumpsum investing in such
scenario).
Ofcourse in practice, the markets neither go up nor go down continuously for very long. So the actual reality may be somewhere in between the two above discussed scenarios of sip vs one time investment in mutual funds.
In some cases, SIP may give better
returns than lumpsum investing. While in other cases, lumpsum will give better
return than SIP investing. And in many other cases, the result of both will be
pretty similar.
It all depends on the future sequence of returns that the investor gets. If you want to know how much wealth your SIP will create, try using this SIP maturity value calculator.
But let me
circle back to the original point I made – whether
you invest lumpsum or otherwise first depends on whether you have a lumpsum or
not.
Right?
And if you
have, then obviously it would be wiser to just invest lumpsum when the market
is low. Remember Buy-low-sell-high?
But problem
is that you will never know when the market is really low. You can be wrong
about your assessment and enter at precisely wrong times.
And that
said, what about our ‘real’ nature and how we behave?
Most
investors are unable to use common sense when their portfolios are down.
But very
few people have the guts to go out and invest more money (assuming they have
more). Fear plays a major role in investing and unfortunately, you can neither back-test
emotions nor fear. And you will only know in hindsight whether is it best time
to invest in mutual funds or not.
Imagine
investing lumpsum in December 2007 when markets were peaking and then
helplessly witnessing the fall down till March 2009. On the other hand, if you
invested a lump sum in March 2009 instead (at the bottom), you would have been called
the next Warren Buffett!
Both are
extreme examples but show how lumpsum investors potentially expose their portfolios
to the vagaries of the market. There is always the risk of being completely
wrong and mistiming. And that is the problem. To be fair, one can also get the
timing right and if willing to spend sleepless nights in the short term, can go
on to make much higher returns than usual in medium to longer term. But that’s
how the dynamics of lumpsum investments are.
Due to their
structural nature, SIPs reduce this risk of being completely wrong as the
investments are spread out. So asking whether is this the right time to invest
in SIP is immaterial as SIP spreads out your investments. Ofcourse your returns
will depend on how the markets play out during the spreading-out period. But
that is how it is.
For small
investors, SIP is also suitable from their cashflow perspective. They rarely have
access to large lumpsum that is ‘surplus enough’ to be available for long term
investing.
By putting away small amounts periodically, there isn’t a large pressure on their resources and no doubt is convenient. This is the reason that for small investors, SIP is their best bet even if not a perfect strategy.
Remember
that SIP is a tool to optimize returns and match your investment needs to your
cashflows. It is not a magician’s magic to generate superior returns to lumpsum
investing. Read that again.
One can use the SIP investing to slowly build up a large corpus over the years without straining the finances in present or worrying about timing the markets perfectly. You can try to use this sort of yearly SIP calculator to understand how much money you need to save for various financial goals.
I know that
many of you are more focused on saving taxes.
And one popular way to save taxes these days is to go for best tax saving ELSS funds vs PPF. But there also, people tend to get confused whether to go for SIP or lump sum for ELSS when investing in top ELSS mutual funds. Nevertheless, the logic that we have been discussing till now remains the same irrespective of whether it’s an ELSS fund or a normal mutual fund.
Now let’s take
a step further…
What if you
have a lump sum that can be invested. Should you go ahead and invest it in one
go or do something else?
Should you Invest Lump Sum
In One Shot Or Systematically & Gradually?
A smart
investor would recognize the market bottoming out and invest in one go. But we
all aren’t smart. So if you aren’t sure if it’s the right time to invest in one
go, you can even deploy your lump sum gradually.
There is no
one single answer to which is the best
method to invest a lump sum in mutual funds?
So
depending on the market conditions, investor’s investment horizon and risk (and
volatility) appetite, a deployment strategy may have to be worked out. This
strategy may either aim for lowering risk or maximizing returns or a
combination of the two.
One way is
to put lump sum investment in debt mutual fund and gradually deploy the money using
STP or Systematic Transfer Plan into an equity fund.
Different
investor needs would demand different lumpsum deployment strategies.
Being a small investor, it can be daunting to find out which are the best SIP plans that can be considered for long term investments. Or for that matter to find out which are the best mutual funds for lumpsum investment or the best tax saving mutual funds in India or whether to do ELSS SIP or lump sum.
If you don’t know how to find good funds or need help with planning your investments, do get in touch with a capable advisor to help you. It is worth it.
Finally…
I am sorry
if you did not find the one specific answer to your question of SIP
or Lumpsum which is better for investing.
A direct
comparison between SIP and lumpsum investing is neither fair nor accurately
possible. And unless we know everything about the investor in question, one
cannot say confidently which is better suited for whom.
You may feel that there is a secret to find the best time to invest in mutual funds India but there is no secret. Different investors need to follow different investment strategies for SIP and lump sum investing. And ofcourse an awareness of market conditions and how market history plays out is absolutely necessary. You can’t be blind to that.
All said
and done, SIP is a comparatively safer option but we cannot deny that at times,
lump sum investing will provide better returns if done correctly.
Which is better SIP or lump sum investment in top best mutual funds in 2019?
This may
sound repetitive but the truth is the superiority of SIP over lump sum or of
lumpsum investments over SIP varies under different conditions.
Is SIP better
than one time investment? Or lump sum is better than SIP? Systematic Investment
Plan vs Lump sum Investment? It is all a matter of probability and what is the sequence
of returns that comes in future and how investor behaves during the period in
consideration. That’s all there is to it.
This is a common question that I am asked quite often, more
so during the tax saving season.
Choosing between the ever so popular Public Provident Fund (PPF) and Equity-linked Saving Schemes (ELSS).
To be fair, comparing one to the other isn’t exactly
correct. But I will get to that in a bit.
If you think about it, the main motive behind such PPF vs ELSS questions is fairly obvious – the more tax you pay, the less money remains in your hands. So you will naturally try to find ways to save more taxes. And if these tax saving efforts can help you earn good returns, then nothing like it. Isn’t it?
Unfortunately, people want a clear-cut, crisp,
one-word answer to such ELSS vs PPF questions.
But that’s easier said than done. Things aren’t
always black and white. There are hundreds of shades of greys in between.
Another question derived from the earlier one is whether doing SIP in ELSS funds is better
than investing in PPF every month?
Those who are risk averse obviously feel PPF is a better savings option. While those who have got good returns from ELSS funds in the past (or know that equity is the best asset to create long-term wealth) advocate going for SIP in ELSS funds.
And here is an interesting fact: the number of such PPF vs tax saving ELSS debates
rises during the tax saving season. JPeople are in a mad rush to do some glamorous,
last-minute tax savings and portray themselves as financial superheroes!
But last-minute tax saving efforts near the end of the
financial year is a recipe for disaster.
But let’s not digress and instead focus on the main questions
at hand:
Is ELSS mutual fund better tax-saving investment option than PPF (Public Provident Fund)? Or
Is PPF better tax-saving option than ELSS funds (Equity Linked Saving Schemes)?
No doubt both are very popular.
And when you ask people about the best tax saving
investment options, chances are high that you will get either ELSS or PPF as
the answer.
But as I said earlier, there is no perfect or one clearly
defined right or wrong answer to this debate.
Ofcourse if you pick just one of the several parameters,
you are bound to find one clear winner. But that is not the right approach.
But let’s begin the comparison anyway…
Most people prefer to compare returns.
Unfortunately, that is neither wise nor a fair
comparison.
PPF
as a product is extremely safe and gives assured returns whereas returns
from ELSS depend on the performance of the stock markets. So the returns of
ELSS can be very high or very low and fluctuate somewhere in between.
Both are completely different products and target
different needs of a portfolio. So we shouldn’t even be comparing them!
But people do and will continue to compare.
And one very big reason why people compare them is that both have a good and instant side-effect of providing tax-saving… that too under the same Section 80C of the Income Tax Act. Hence people tend to compare.
I know what you are thinking.
Firstly, we are concerned about tax-saving. Right? That’s
common between ELSS and PPF. So nothing much to compare.
Next obvious choice is to compare returns. What else
could it have been?
You are right to an extent.
But I am of this view that all investments should be linked to financial goals. Tax saving should not be the prime motive for most investors (Talking of goals, if you still aren’t sure which goals you are or should be targeting, I strongly suggest you use this FREE Excel-based Financial Goal Planner to find out what your real personal financial goals are.)
Your goals and investment horizon play a major role
in defining how you invest. If investing for long-term goals, the investment
portfolio should ideally have a larger equity component. Whereas when saving
for short-term goals, it should be a less volatile and debt-heavy portfolio. The
asset allocation differs for different financial goals. That’s how it should
be.
I will not delve into the full details of what PPF
is or what tax-saving ELSS funds are. I am sure you already know most things
about them. But just to recap a bit:
PPF (or Public Provident Fund) is a government-backed debt product that assures returns that are declared from time to time. How much to invest in PPF to save tax? A maximum of Rs 1.5 lakh can be invested in lump sum or installments in one financial year. The lock-in period is 15 years and the account can be extended in blocks of 5 years multiple times after the original 15-year maturity period is over. Tax benefits for investment in PPF under Section 80C are limited to upto Rs 1.5 lakh.
ELSS (or Equity Linked Savings Scheme) is a diversified mutual fund that invests in stocks and also offers benefits under Section 80C. There is no limit on maximum investment but tax benefit is available only on Rs 1.5 lakh. The lock-in period is 3 years. Returns are neither guaranteed nor assured. They are market linked and (average returns) tend to beat inflation in the long term.
Comparison of Returns – ELSS vs PPF
As I have already said, comparing returns of PPF
with ELSS isn’t 100% correct.
Both have very different investment objectives.
PPF is a debt product whose returns are fixed but
limited due to its very nature. There is no potential for positive or negative
surprises. You get what you are promised by the authorities. ELSS, on the other
hand, is an equity product that aims to maximize returns. To achieve this aim,
it takes risks which can turn out well at times and not turn out well at other
times.
To give you some idea about how returns in ELSS
funds and PPF differ every year, I have tabulated the annual returns of some of
the popular tax-saving ELSS mutual funds in the table below:
The data has been sourced from Value Research. This is not a perfect comparison but is still good
enough to give you a comparative snapshot. You can compare the year-wise
returns and average category-return of these ELSS funds with PPF annual
interest rates. This table will give you some idea about how the returns vary
in reality, so I suggest you spend some time on it.
And the funds above are one of the best ELSS funds
that have been in existence for last several years now. But do not think of
this as an advice of best-ELSS-funds-to-invest kind of list. The data is just
for illustration purposes.
But nevertheless, read the observations below:
PPF returns have mostly ranged from 8.0% to 8.7% in the recent past. To know more about PPF account interest rate in different banks, check the updated latest PPF interest rates.
The years with green colored PPF-return grids indicate that the PPF was the better performing when compared with other ELSS funds in that year. Like in 2008, PPF delivered 8% whereas the chosen set of ELSS funds gave average returns of -54% with individual funds delivering anything between -48% to -63%. Similarly in 2011, PPF did better than ELSS schemes.
The years with red PPF return grids show that ELSS gave higher returns than PPF in those years. For example: in 2017, ELSS returns ranged from 26% to 46%. Obviously PPF couldn’t match that with its 8%.
The smaller grids (max/min) show the maximum and minimum annual return for different ELSS funds for that given year.
It’s clear from above that depending on the market conditions,
the ELSS returns can have wild fluctuations. PPF returns on the other hand are
more or less constant due to government’s blessings.
So where PPF returns average around 8%, tax saving
ELSS mutual funds have the potential to deliver a much superior return – a 12%
to 15% average returns is possible, but not guaranteed. And the top best ELSS
funds have given much better returns than these average returns.
So does it mean that you should simply dump PPF and
start investing everything in ELSS funds?
Ofcourse not! The average return comparison of ELSS and PPF does seem to show that ELSS offers superior returns in the long run. But basing your investment decisions only on one factor is very risky. Here’s why.
Let’s check another aspect before we get judgmental.
A lot of people don’t invest in lumpsum and rather
invest every month. So for them, it’s better to find out how SIP in ELSS
funds Vs monthly PPF investment compares.
Let’s check that out too.
I have simulated Rs 10,000 monthly investment in Franklin India Tax Shield Fund* starting
from January 2008 to December 2018. This is to be compared with Rs 10,000 per
month savings in PPF for the same period.
*Chosen randomly
from several ELSS funds. Don’t consider it as a recommendation.
The value of investment in Franklin’s ELSS fund at the end of 2018 would be about Rs 29-30
lakhs. On the other hand, the value of PPF corpus is 20-21 lakh.
Once again and maybe not surprisingly, it seems ELSS
is the way to go.
You can also say that in the above case, the
PPF-investor has actually lost out on more than 50% extra returns. (Rs 30 lakh
– Rs 20 lakh)
I have compared Rs 10,000 monthly SIP in Franklin Tax Shield vs monthly 10,000
savings in PPF starting from April 2007 (when the bull run was about to peak in
coming months).
I chose that starting point because due to high
returns from equity in recent past (2004-early-2007), many people would be
attracted to stock markets and would be interested in ELSS – as it combined tax
savings with much higher returns than PPF.
So here is a 2-year story – starting from April 2007
to March 2009:
In 2 years, the total contribution would have been
Rs 2.4 lac in each.
And the value of ELSS investment would be Rs 1.6 lac
and that of PPF would have been about Rs 2.6 lac (yellow cells in the bottom
row).
Now think…
We know equity will do well in long term. That is
what has been told and proven countless times
But how many people would remain convinced and loyal
to that idea when their Rs 2.4 lakh investment goes down to Rs 1.6 lakh after 2
years?
They might be cursing themselves for ignoring PPF
that would have saved them from such losses.
And this is what I wanted to highlight.
And no PPF vs ELSS calculator or SIP vs PPF
calculator will tell you this. All such ELSS SIP investment calculators work on
the principle of average returns which will not show the real picture.
Just looking at historical average returns, you might feel that investing 100% of the money in stock markets is the right way. But when markets correct, not many people have the ability to stay invested and accept the temporary losses, even though it is best for them.
Looking at the average long-term returns in
isolation can give the wrong picture. Equity investing (directly or via mutual
funds) does need a lot of will power to remain invested when markets are down.
Not many people have it.
So is it better to
invest in ELSS mutual funds SIP than in PPF?
It is true that
investors of ELSS mutual funds are rewarded for accepting the short-term
volatility. They are paid back handsomely as average return table above suggests.
But when you invest in markets, you will face periods of stock market
volatility every now and then. Like in 2008, the ELSS category fell by almost
50%. Again in 2011, the category average was about -24%.
Equity is perfectly fine for long-term investors and
equity funds have given much better returns than PPF over long-term. But you
just cannot ignore debt (like PPF) as the investors have different responses to
volatility. Some might exit ELSS after 20-30% losses (which is normal in
equities).
Another factor is that you don’t have to ‘choose’
anything in PPF. It’s simple.
But in ELSS funds, you have to choose the fund among
many available ones. Is there any guarantee that you will be able to choose the
right ELSS fund that will do well in future? Think about it. What if you picked
the wrong funds?
That was about the
comparison of investment returns of PPF vs ELSS mutual funds.
Let’s see other
factors.
Tax Benefits on investments in ELSS Vs PPF
Both ELSS and PPF
are quite tax efficient.
Under the Income Tax
Act Section 80C, investment in ELSS mutual funds and PPF (Public Provident
Fund) give you a full tax deduction upto Rs 1.5 lakh every financial year.
Under Section 80C, you cannot claim deduction of more than Rs 1.5 lac when investing in ELSS or/and PPF and/or other section-80 tax saving options.
Also, you cannot
invest more than Rs 1.5 lakh in a PPF account in a year. But this restriction is
not there in ELSS schemes. You can invest as much as you want, but the tax
benefits available will be limited to Rs 1.5 lakh.
And let me answer
two more questions that you might have:
A PPF account has a
maturity period (lock-in) of 15 years. ELSS funds on the other hand have a lock
in period of only 3 years. But wait. There is more to know than just that…
Assuming you make
annual investments in PPF, only your first installment in locked-in for 15
years. The 2nd year installment is locked-in for 14 years. The 3rd year
installment is locked-in for 13 years…and so on. Also, the PPF accounts that
have completed 15-year lock-in and have been extended have a fresh lock-in of
only 5-years.
In ELSS, each SIP
installment has its own 3-year lock-in. many people get confused here. Do not
think that lock in is valid on full amount that you have invested from the date
of first investment in ELSS.
So first SIP in
April 2017 will be locked in till April 2020. Second SIP in May 2017 will be
locked-in till May 2020. And so on…
But let me remind
you that equity is best suited for long-term. Like for periods exceeding 5
years. The money is locked for only 3 years in an ELSS fund. But even if the
lock-in gets over after 3 years, you shouldn’t withdraw the funds and remain
invested for as long as you don’t need the money.
As investors you need to be very clear that the asset that you are investing in is equity and thus you should be ready to stay invested for at least 5 to 7 years to get good returns.
What if you Invest 100% in PPF or 100% in ELSS?
These type of questions come from people who are unwilling to see the
bigger picture and are only narrowly focusing and asking about PPF vs mutual
funds which is better?
But neither approaches is advisable.
Is PPF a good option for investment?
Is ELSS a good option for investment?
Ofcourse yes.
But theoretically speaking, if you invest Rs 1.5 lakh in PPF every year for 15 years, your total corpus would be around Rs 43 lakh. You can use this Excel PPF Maturity Calculator to try out other scenarios (or find out how to save Rs 1 crore in PPF).
Regular SIP in equity funds (both ELSS and non-ELSS) can create a lot of wealth in long run. Here is a good real-life success story of SIP-based Wealth Creation. To know how much wealth you can possibly create by investing small amounts every month, check out the following links:
Again, you might
feel that why to use PPF when you can get more returns with ELSS.
But remember, PPF is
a debt product and ELSS is an equity product. All goal-based investment
portfolios are best constructed by diversifying across assets.
You should not be 100%
in equities or 100% in debt.
It is not sensible
either way.
For most people, the best approach is to invest in line with your goal requirements. Using the powerful concept of Goal based Investing, you find out how much you should be investing for each goal.
Let’s assume that the goal you have in mind is retirement planning – which is a nasty problem in itself.
It’s a big goal. And
since for most people its decades away, its best served by an equity heavy portfolio.
For someone in 30s,
it can be safely said that a portfolio with 70% equity and 30% debt is
suitable.
And you also wish to
save tax. Right?
So here is how to go
about it:
You are investing for your financial goal of retirement planning.
After doing some calculations yourself (or taking help from an investment advisor), you have come to know that you need to invest Rs 20,000 every month in 70-30 Equity-Debt ratio.
That means investing Rs 14,000 in equity and Rs 6000 in debt every month.
But you are already making an EPF contribution of Rs 4000 every month. That also counts towards the 30% debt bucket.
EPF takes care of 48,000 under Section 80C tax saving options. Assuming you have a Rs 1 crore term insurance with Rs 12,000 annual premium, the total eligible deduction goes upto Rs 60,000 (48K+12K).
The remaining Rs 2000 per month (from debt) can be put in PPF. Or if you have the option of VPF, that’s better too. This totals to Rs 84,000.
And this increases eligible deductions to Rs 84,000 (48K+12K+24K). You need another Rs 66,000 for fully utilizing Section 80C limit.
You can now do a Rs 5500-6000 SIP in ELSS fund. That will take care of your tax-savings.
For the remaining Rs 8000-9000 (in equity bucket of Rs 14,000), you can choose other normal equity funds (non-ELSS). Or you can even do full Rs 14,000 SIP in ELSS funds.
And if you think
like that, then you will easily get answers to questions like ‘how much should I invest in ELSS’ and ‘how much should I invest in PPF’?
But you don’t need
to decide between PPF and ELSS because of just returns.
You instead simply need
to focus on asset allocation (which is 70-30 in the above example). Therefore,
the choice between doing SIP in ELSS funds and investing in PPF must also be
seen in the context of overall portfolio asset allocation.
If there is room
under the 30% debt bucket after deducting EPF contributions, you use PPF. For
equity’s 70% bucket, you can use ELSS to the extent it is needed for tax
saving.
And if your Section 80C limit of Rs 1.5 lac is fully utilized using EPF contributions, life insurance premiums and home loan principal repayment, there is no need for ELSS mutual funds investment. You can easily focus on non-tax saving equity funds instead.
But that doesn’t mean that you don’t invest for your goals. Tax-saving
is not a financial goal. Just remember that.
The approach that I discussed above is in line with goal-based
investment’s philosophy.
One simpler approach can be to take a middle path and do a 50-50 split
between PPF and ELSS.
Another can be (for those who are interested in being more tactical
about tax-saving) to use market valuations as an indicator to decide where to
invest. If valuations are low, invest in ELSS. If valuations are very high,
invest in PPF.
I am not suggesting that the tactical approach discussed above is a better way. Just highlighting that there can be multiple approaches. But most people are better off not trying to time the markets. 🙂
But the actual split between ELSS and PPF will depend on factors like
your risk profile, existing assets, etc.
Just to reiterate, if you are young, keep a larger portion of your savings directed towards equity when investing for long term goals like retirement.
Both ELSS and PPF are suitable for retirement savings. But equity is
better suited as long as you have several years left for the goal.
How to choose good Tax-Saving ELSS Mutual Funds?
Before even you consider ELSS as the choice for tax saving, do not
forget that always invest in ELSS with a long-term perspective – something like
5+ years or even more.
Why?
Because ELSS is about equity investing. And equity as an asset class
isn’t risk free. There is always a risk of loss of capital. But this risk is
higher when you invest for short term. The longer your investment horizon, the
lower is the risk of loss.
With that aside, how do we go about picking the best ELSS funds among
all ELSS mutual fund schemes out there?
These days, the disclaimers about past performance not being
necessarily sustained in the future fall on deaf ears.
So despite mutual fund companies highlighting great short term returns,
you should focus on things that matter.
When looking for which ELSS funds to invest in for tax saving, keep the
below discussed points in mind.
Depending solely on performance numbers from recent past can be misleading. Do not run after previous year’s best performing tax saving ELSS funds. Look for consistency in returns over several years. Has the fund been in the top quartile of its category for almost all the years? Has the fund protected the fall in poor markets? These are just some of the questions that should come to your mind when picking ELSS or building a proper mutual fund portfolio. You can even consult an investment advisor to find out these answers.
Also, all ELSS funds are not the same in terms of portfolio
construction.
All ELSS funds are actively managed and its fund manager’s job to
decide what to hold in fund’s portfolio. It can a portfolio with a bias towards
large cap, midcaps, all caps or whatever.
What is worth remembering is that one ELSS fund’s investment mandate
will not be the same as that of the ELSSs out there.
And there is absolutely no need to pick a new ELSS fund every year for your
tax saving.
This often happens when you do last minute tax saving. You are in a hurry and want to find out the best performing ELSS fund on the basis of 1-year return. This is not advisable.
Over the years, investors end up with several ELSS schemes as they
invest lump sums every year by picking one from the best performer of previous
years. Like picking from Top ELSS Funds of 2018 or Top ELSS Funds of 2019.
But having more than 1 or 2 ELSS funds is useless. In any case, if you have other non-tax saving diversified mutual funds, having more ELSS funds will only lead to an overlap in your portfolio. Building a mutual fund portfolio isn’t tough but still people mess it up.
So don’t wait for January, February or March for planning your tax
savings.
Do some homework earlier and find out how much is to be invested in ELSS in the year. And then begin investing in ELSS through SIP (systematic investment plans). This way, you would have time to pick good ELSS funds on the basis of long-term consistent performance. You will also benefit from averaging (and avoid timing the market through last minute lump sum investments).
We began this article with the question of whether to invest in PPF
or ELSS to save taxes.
You should not decide randomly between ELSS or PPF. And there is no
one-size-fits-all answer as both ELSS and PPF target different needs of the
investment portfolio.
The decision should be made after you have a clear view of your financial
goals and tax requirement.
But when it comes to combining equity investing with tax saving, there
is no doubt that ELSS is good for long term investments. It scores well
above several other tax saving products. And investing in ELSS through SIP (or
systematic investment plans) over a long time horizon can help you do proper
tax planning and financial goal planning.
If you have a well-thought out investment plan for your financial goals, you will not need to ask questions like which is a better investment option ELSS or PPF?
You don’t need to choose between the most suitable tax saver between ELSS vs PPF. That is because you will invest on basis of your goal-specific strategic allocation rather than randomly. And that is what goes a long way in sensible investment management and wealth creation. So taking sides on ELSS vs PPF is fine. But invest smartly and using correct goal-based approach.
Budget 2019 initially proposed something that excited millions of Indians – No income tax on Rs 5 lakh income.
It seemed that the zero percent (0%) income tax slab was indeed increased to Rs 5 lakh in India.
But when actual details emerged, the reality was a little different.
If you still aren’t sure about this whole zero tax 5 lakh thing or are looking for answers, then this article might help.
What really happened is something like this:
Individuals with taxable income of up to Rs 5 lakh will get full tax rebate under section 87A. What this means is that if your net taxable income is up to Rs 5 lakh, then you don’t need to pay any taxes. However, if the net taxable income is above Rs 5 lakh, then the rebate under Section 87A cannot be availed.
But, there are no tax slab changes in the Budget 2019.
The only thing that has changed is the tax rebate under Section 87A – which has been revised; and it’s because of that alone, that there will be no tax liability for those whose taxable income is less than or equal to Rs 5 lakh (Rs 5,00,000) in India.
If this sounds a little confusing, then let’s go step-by-step and it
will be crystal clear to you by the end.
Income Tax Slabs FY 2019-20 (AY 2020-21)
As I said, there hasn’t been any revision in the income tax slabs from the previous year. It remains the same the for Financial Year 2019-20 as follows (for individuals below 60):
This simply means that, currently:
Taxable income up to Rs 2.5 lakh has zero (nil) tax.
Taxable income between Rs 2,50,001 to Rs 5,00,000 taxed at 5%
Taxable income between Rs 5,00,001 to Rs 10,00,000 taxed at 20%
Taxable income above Rs 10,00,000 taxed at 30%
In addition to the above, following are also applicable: 10% surcharge on income tax if Rs 50 lakh < income < Rs 1 crore and 15% surcharge on if the total income > Rs 1 crore.
4% Health & Education cess on income tax (including surcharge) to be added.
Remember, we are talking about the ‘Taxable Income’ here and not ther ‘Gross or Total Income’. The ‘net taxable income’ is the total income reduced by the amounts of permissible deductions under various sections (like Section 80C, etc.).
I know you might be thinking – if the tax exemption limit is still Rs 2.5 lakh, then how can there be zero tax on income of up to Rs 5 lakh?
Your curiousity is correct.
And the reason is hidden in the changes made in the Section 87A during the Budget 2019.
Revised Tax Rebate – Section 87A
What has happened is that the limits specified earlier in Section 87A
have been revised. The changes are as follows:
Earlier: If the taxable income is less than Rs 3.5 lakh, then a rebate of Rs 2500 applies to the total
tax payable (before cess). And if the tax payable is less than Rs 2500 then the
entire tax amount is discounted.
Now (after Budget 2019): If the taxable income is less than Rs 5 lakh, then a rebate of Rs 12,500 applies to the total tax
payable (before cess). And if the tax payable is less than Rs 12,500 then the
entire tax amount is discounted.
So the earlier limit of Rs 3.5 lakh has been revised upwards to Rs 5
lakh. And the rebate available has been increased from Rs 2500 to Rs 12,500.
Remember, that a rebate is the specified amount of tax that the taxpayer is not
liable to pay.
Here is simple example to show the working
How Income Tax is Zero (nil) on Rs 5 lakh income?
Suppose, your net taxable income is Rs 5 lakh.
As per the tax slabs, calculated normal tax liability is as follows:
0 to Rs 2.5 lakh –
0% – Nil
Rs 2.5 lakh to Rs 5.0 lakh – 5% of Rs 2.5 lakh – Rs 12,500
(ignoring cess, etc. for simplicity)
So the total tax = 0 + Rs 12,500 = Rs 12,500
But, the revised Section 87A limits offer a rebate of Rs 12,500 for
taxable income of up to Rs 5 lakh.
Result
Tax of Rs 12,500 – Rebate of Rs 12,500 = Zero Tax.
That is, if the net taxable income is Rs 5 lakh or less, then the entire tax liability will be less than the rebate of Rs 12,500 – which means effectively no (zero) tax on income up to Rs 5 lakh.
So you can say that the so called zero tax is applicable only for those whose taxable income is Rs 5 lakhs or less.
But what happens in case taxable income is
more than Rs 5 lakh?
Let’s see…
Income Tax on income above Rs 5 lakh
If you wish to calculate income tax on your net taxable income above Rs 5 lakh, then let’s take an example to understand it.
Since your taxable income is Rs 5.5 lakh, which is not less than Rs 5 lakh, you are not eligible for the rebate under Section 87A of the Income Tax Act.
So your tax liability remains as Rs 22,500 and you have to pay the full amount. Sorry! But you can still be wise about tax planning by giving priority to your investment planning.
It makes sense to repeat that the rebate is available only if taxable income is Rs 5 lakh or less. Not if it’s above it.
Had you by some means been able to further
reduce your taxable income to less than Rs 5 lakh (in above example of Rs 7
lakh total income), you would have become eligible for the rebate of Rs 12,500.
So that’s it…
There has been no change in income slab or tax
rates in Budget 2019. Only the limits in the Section 87A have been revised to
benefit those whose taxable income is less than Rs 5 lakh.
Individuals with taxable income of up to Rs 5 lakh will get the full tax rebate under section 87A. This effectively means that they will not be required to pay any taxes. However, for those whose net taxable income is above Rs 5 lakh, there is not tax rebate that they can avail.
I hope this article clarifies your doubts about how income of Rs 5 lakh is tax free and what is the zero percent (0%) income tax slab in India.
Rs 1 crore is still not a small amount. But whether it is sufficient or not depends on why you actually need it.
So for example, if you were to ask me whether Rs 1 crore is enough for retirement? In most cases, the answer would be a No. Retirement planning is a nasty problem and you can’t just ahead with random numbers for your retirement corpus.
But still,
there is a psychological attraction to this figure of Rs 1 crore and becoming a
crorepati that us Indians can relate to.
PPF is a beautiful debt product. I have already written about it earlier too (link).
And even though investing in equity is a necessity and highly advisable for the long term, a product like the PPF can still be a part of the overall portfolio. And I am sure the term PPF crorepati in the title would have already captured your interest by now. 🙂
However,
PPF is not a short term investment option as it has a lock-in period of 15
years. But still, you can make partial withdrawal after few years. And You can
even extend the maturity by a block of 5 years for multiple times. It currently
falls under the ‘EEE’ category, which means that PPF contribution, interest
earned on PPF and PPF maturity proceeds are exempted from tax.
Interestingly,
a few days back I got a mail from a self-confessed conservative investor.
He said that he was slowly increasing his equity investments. But still he felt that he cannot part ways with something as sure-shot and as risk-free as a PPF account. And he wanted to know how long would it take to accumulate Rs 1 crore in PPF?
I felt that
this question might interest others as well.
So this
post is about finding out:
How to accumulate Rs 1
Crore in PPF (Public Provident Fund)?
And if you
are low-risk conservative investor who wishes to accumulate Rs 1 Crore,
then PPF is a decent option.
Let me try
to answer this from various perspectives:
If you contribute Rs 1.5 lac every year for a period of 15 years, your
PPF balance will be about Rs 43.9 lac at the end of 15 years (assuming a stable
interest rate of 8.0% per annum).
If you contribute Rs 1.5 lac every year for a period of 15 years and
then don’t liquidate your holding for another 15 years, then your PPF balance
will be about Rs 1.39 crore at the end of 30 years (assuming a stable interest
rate of 8.0% per annum). You will achieve the target of Rs 1 crore around the 27th
year.
If you contribute Rs 1.5 lac every year for a period of 15+5+5+5=30
years, then your PPF balance will be about Rs 1.83 crore at the end of 30 years
(assuming a stable PPF interest rate of 8.0% per annum). And you will reach Rs
1 crore during the 24th year itself.
But what if
you are unable to invest Rs 1.5 lac every year (the full PPF annual limit),
then obviously your target of reaching Rs 1 crore in PPF will be delayed
accordingly.
Also, if
the interest rates go down in years to come, then once again your target of
reaching Rs 1 crore in PPF will be delayed to that extent.
So to sum it up, you can become a crorepati if you put Rs 1.5 lac every year in PPF then you can accumulate a corpus of Rs 1.08 crore by the end of the 24th year (assuming that 8% return)
But as you know, neither the PPF limit remains same nor PPF interest rates remain unchanged over the long term.
So let’s
try a hypothetical scenario which might actually play out in the near future:
Suppose you begin saving full Rs 1.5 lac in PPF today. Government increases the annual PPF investment limit by Rs 50,000 every 5 years. It is assumed you will continue to invest as much as is needed to fully utilize the annual investment limit of PPF every year. The interest rates also reduce by an average 0.5% every 3 years or so.
What will
be the result then?
At the end
of 15th year, your total investment of Rs 30 lac would have become about Rs
49.4 lac.
If you
continue investing (after extending your PPF account with contribution) for
another 5+5+5=15 years, then at the end of 30th year, your total investment of
Rs 82.5 lac would have become about Rs 2.02 crore.
Here is the
tabular depiction of the excel:
As you might have observed by you, it is only after the initial few years that the actual compounding of the PPF investments becomes visible. And it is for this very reason that you should try not to disturb (withdraw from) your PPF account for as long as possible and try to extend its tenure after the first 15 years lock-in period.
Do you want
to try some different scenarios of your own?
You can do
so.
You can
download this FREE Excel PPF Calculator and play around with inputs. If the previous
link doesn’t work, use the link below:
You can even check out historical PPF interest rate and how things have changed in the past when it comes to PPF.
Now, the
current limit for PPF is Rs 1.5 lakh per year.
But what if
you want to invest more?
Obviously,
you need to respect the limit.
But if both
husband and wife can contribute to PPF, then things can get fastened a bit.
Save Rs 1 crore Quickly using
Husband PPF + Wife PPF
What needs to be done is that a PPF account needs to be opened for both you and your spouse.
Since both the husband and the wife can deposit Rs 1.5 lakh per annum, it means you can contribute Rs 3 lakh every year in PPF. And you will get interest in both these PPF accounts for the entire period of 15 years or more if extended.
So how much
do you end up with if both you and spouse contribute Rs 1.5 lakh every year for
15 years?
The answer
is Rs 43.9 lakh each, i.e. a total of Rs 87.8 lakh.
So if both
of you save diligently, you can achieve Rs 1 Crore in about 17 years. Here is a
sample depiction of PPF Husband Wife calculation:
So if you are a conservative investor, who isn’t much interested in volatile investment options, then PPF can be helpful. PPF can help you become a crorepati in a safe way.
If you put Rs 1.5 lakh every year in PPF, then you can accumulate a corpus of Rs 1 crore by the end of the 24th year.
If both you and your spouse put Rs 1.5 lakh each every year in individual PPFs, then you both accumulate a corpus of Rs 1 crore by the 17th year itself.
And if
somehow you manage to continue investing for the 30 years (i.e. 15 year
original and 3 extensions of 5 year each), then you will be able to accumulate
a really big corpus.
So before I
close, let me list down some facts about the PPF for your ready reference:
Extension of PPF Account – After the maturity period of original 15 years, it can be extended in blocks of 5 years each multiple times
Minimum deposit amount (per year): Rs 500
Maximum deposit amount (per year) : Rs 1,50,000
Number of installments every year: 1 (min) to 12 (max)
Number of accounts an individual can open: Only 1. If there is a 2nd PPF account, it is treated as invalid and doesn’t earn any interest.
Tax Savings – EEE status, i.e. the annual contribution (upto Rs 1.5 lakh) provides tax benefit under Section 80C. Interest earned and the maturity amount is fully exempted from taxes.
Interest on PPF is calculated on the minimum balance in the account between 5th and the last day of each month. So if you invest monthly, then it makes sense to do it before 5th every month.
You can further maximize your returns in PPF by investing the full amount at the beginning of the financial year itself. Ofcourse this is not easy for everyone. But if you do so, the full amount earns interest every month of the year.
Here is the link to download the free excel-based PPF Calculator again:
Investing in equity does come with its own share of ups and downs in the near term. But if you look at the average annual returns of Indian Stock Market, then it will show how you can create some serious wealth from equity. The idea of this post was to tell how a comparatively safe and risk-free savings option like PPF can be used to accumulate a large corpus of PPF Rs 1 crore.
For most people, its advisable to have a balance between equity and debt when investing for long.
But if you aren’t sure whether you are saving and investing properly, do get in touch with an investment advisor soon (how?).
When it comes to buying life insurance for yourself, the best option is to go for a simple term insurance policy. Period.
With that aside, your next question would be – which is the best term insurance plan to buy?
The answer isn’t simple anymore.
Earlier, term plans came in just one version, i.e. they paid lumpsum (sum assured) at the death of the insured person.
But now, the insurance companies have introduced many variations of these term life insurance plans.
Majorly, these variations give the policyholder different options to decide how the total sum assured is paid out to the nominee in case of policyholder’s death.
But think about it…
Why would you anyone even think about the other versions of the simple term plan?
It will become clear as I explain it in the next sections.
You will realize that just buying a Rs 1 crore term plan or some other plan is not enough. You really need to think hard about how the money will be handled after you and accordingly, choose the right version of the term plan.
So let’s move on…
Types of Term Insurance Policies in India
Let’s see how these term plan varieties differ from each other.
1 – Term Plan with Lumpsum Payout
This is the most basic version.
Let’s say you buy a term plan of Rs 1 crore. In case you die during the policy tenure, your nominee will be paid the full amount of Rs 1 crore in one go. Nothing more, nothing less.
There is nothing much to explain about this option.
In this plan, there is no lumpsum payout. Instead, the sum assured is utilized to provide a regular monthly income to the nominee for a fixed number of years.
For example – You take Rs 1 Crore term plan. Now if you die within the policy tenure, then the sum assured is paid out as a monthly income of Rs 83,333 for next 10 years (i.e. Rs 83,333 x 12 x 10 = Rs 1 Cr).
This monthly income can either be fixed (as above) or can also be increasing one.
3 – Term Plan with Lumpsum + Fixed Monthly Payout
In this plan, a percentage of the sum assured is paid out at the time of death. The remaining amount is paid as a monthly income, which is a fixed percentage of the remaining sum assured for a fixed number of years.
For example – You take Rs 1 Crore term plan. Now if you die within the policy tenure, a percentage of the sum assured let’s say 40% (i.e. Rs 40 lac) is paid out immediately. The remaining 60% (or Rs 60 lac) is paid out as monthly income of Rs 50,000 for next 10 years (i.e. Rs 50,000 x 12 x 10).
4 – Term Plan with Lumpsum + Increasing Monthly Payout
In this plan, a percentage of the sum assured is paid out at the time of death. The remaining amount is paid as a monthly income, which increases at a pre-determined percentage on a simple interest basis on every policy/death anniversary for a fixed number of years.
For example – You take Rs 1 crore term plan. Now if you die within the policy tenure, a percentage of the sum assured let’s say 40% (i.e. Rs 40 lac) is paid out immediately. The remaining is paid out as a starting monthly income of Rs 50,000 which increases by let’s say 10% every year. So next year, the monthly payout will be Rs 55,000 and so on. Generally, the total payout in this version is more than the original sum assured.
In both the above options (lumpsum + fixed monthly payout and lumpsum + increasing monthly payout), the lumpsum % can be different as per insurer’s or policyholder’s choice. There are many plans that even pay 100% of the sum assured upfront and additionally pay a monthly income (fixed or increasing) to the nominee.
For example – You take Rs 1 crore term plan. Now if you die within the policy tenure, full Rs 1 crore is paid out to the nominee immediately. In addition, a monthly payout of Rs 50,000 is made for the next 10 years. The total payout in this version is more than the original sum assured. To be exact, it is Rs 1 crore + Rs 60 lac (Rs 50,000 x 12 x 10).
These are the major versions of the term plans that are available these days.
Now let me address the point that I raised earlier – Why would anyone even think about the other versions of the simple term plan where the payout is staggered?
Quite often, the nominees lack proper personal financial knowledge when it comes to handling large sums of money. So once they receive a large amount, they may be unable to properly manage the sudden increase in wealth and end up losing it by listening to the wrong people.
So in order to overcome this concern, many insurance companies came up with various other payout options.
This way, the nominees receive a part of the amount as lumpsum to take care of immediate concerns (like closing all loans, other big expenses in the near term). The remaining amount is paid as monthly payments over a pre-decided number of years, to replicate the regular income pattern and help smoothen the life of the nominees.
That is the major reason for the launch of these different versions.
So depending on the ability of your nominees to handle money, you should pick the adequate option:
If you are sure your nominee is well-versed in personal finance, then you can go for the full lumpsum payout term plan.
If you feel the nominee is better off not having a large amount suddenly (due to any reason you think), then you can go for the staggered-payout term plans.
If you feel that if your sudden death will result in financial chaos (due to outstanding loan or planned big expenses in the near term), then you can take the term plan that pays a % as lumpsum and remaining as monthly income (if you feel the nominee will be unable to handle money properly).
As you might be feeling right now, there are cases where opting for the staggered payout option actually makes sense.
Ofcourse from a purely financial perspective, it’s best to take the lumpsum and invest it efficiently and try to generate income from it for the nominees. But all decisions cannot be taken just from mathematical perspectives.
Do premiums vary for different Term Plans?
Yes of course.
Different versions of the term plan have different premiums.
To give you an idea, here is a snapshot of the various versions, with their benefits and approximate annual premiums for a 30-year old, non-smoking male living in a metro city and buying a 30-year term plan:
The first one is the normal term plan that you know of – pays lumpsum amount (equal to the sum assured at the death of policyholder). Others are different plans paying different monthly incomes which is either fixed or increasing each year.
There are several term insurance premium calculator available online. It’s best to check out the premiums for different types of policies for yourself.
The actual premium that you will have to pay will depend on a variety of factors. If you take a policy for a longer tenure, then it will cost more. In general, shorter the policy term, lower will be the premiums. To choose the right policy term, do read what should be the ideal term insurance policy term?
And I almost forgot telling you about another variety of Term Plans that has been pitched by a lot of agents in recent times – Return of Premium Term Plan.
Is Return of Premium Term Plan Good?
A lot of people who wish to buy term plans have this feeling that since they will survive the policy period, the premium which they are paying will be wasted.
For these people, insurance companies have come up with a term plan where the premium paid over the course of policy tenure is returned back if the person survives.
At the face of it, this seems like a good idea. And this policy did address the concerns of people who thought that the term plans are a waste of money.
But if you deep dive a bit, things aren’t that great. Such policies have premiums much higher than the normal term plans.
If we were to compare a plain term plan (that only pays lumpsum amount) with a term plan (that also only pays lumpsum) with the return of premium option, then the premiums are Rs 9717 for a plain term plan and Rs 24,968 for return-of-premium term plan.
These premiums are for a 30-year old, non-smoking male buying a 30-year term plan living in a metro city.
Let’s compare these two plans a bit more.
The total premium paid is Rs 2.91 lac for plain term plan (Rs 9717 annually x 30 years) and Rs 7.49 lac for return-of-premium term plan (Rs 24,968 annually x 30 years).
In case of death during policy tenure, the nominee gets Rs 1 crore in both cases (as the sum assured is same).
But in case of survival, things change.
In case of plain term plan, you get back nothing – that is, you don’t get back Rs 2.91 lac. On the other hand in case of Return-of-Premium Term Plan, you get back your Rs 7.49 lac.
You may again feel that the return of premium plan is better. But remember that you are paying a high premium for that.
The difference between the annual premium of the two plans is a little more than Rs 15,000 (= Rs 24,968 – Rs 9717).
If you invest this difference amount of Rs 15,000 every year at just 8%, then at the end of 30 years you will have about Rs 18-19 lac. Compare this with the amount the return-of-premium offers you at the end, i.e. Rs 7.49 lac.
So the obvious conclusion is that it’s better to not purchase a return of premium term plan. You are better off with either a simple term plan (or some of its variants that offer monthly income).
But since term plans also come in various shapes in sizes, its natural to ask which is the best term insurance plan for you?
As mentioned earlier, the choice of the term plan variety is dependent a lot on how capable do you feel your nominees are in managing money. If they are financially aware, going for a lumpsum payout is best. If they aren’t and you want to provide them with a regular income for a few years after you die, then take the lumpsum + monthly income payout option. Or you can have the best of both worlds by taking two policies combining the two approaches.
Term life insurance is the most basic form of life insurance. And I can safely say that it’s the most effective and the best form of insurance.
Why?
Because it gives you a very high insurance coverage (sum assured) at a very low premium. It’s perfect!
Many of you know about the benefits of choosing a term plan when compared to the whole menu of the available life insurance varieties. But this post is for those who are still not sure whether buying term insurance makes sense or not.
So here are answers to a few common questions that people have about term insurance plans.
Q1: How does Term Plan work?
A1: The buyer buys a term plan for a specified tenure. Let’s say 30 years. Now if the premiums are being paid regularly, then if the insured person dies between today and the 30th year, the insurance company will pay the sum assured to the nominee. If the person does not die during the tenure of the policy, nothing will be paid to either the insured person or the nominee.
Q2: Most people won’t die. So money paid in term plan premiums will be lost?
A2: Wrong way to look at it. Term plans are incredibly cheap. You can get a term plan of Rs 1 crore for just Rs 10,000 or even lower. On the other hand, a traditional insurance plan (like moneyback and endowment plans) can cost about Rs 25,000 for just a Rs 5 lac cover. The first thing to note is that this doesn’t make sense when you compare it with term insurance premiums. Second is that if you die, a payout of Rs 1 crore is more useful for your family than a payout of Rs 5 lac. Agreed that you won’t get anything back in term plan if you live. But what if you want to buy a Rs 1 crore cover using a traditional plan? Try to find it out. The premium will be so huge that you might not even be capable of paying it. So term plan allows you to give bigger protection to your family at a much lower cost.
Q3: What if I am lucky and don’t die? In any case, the premiums would be lost right?
A3: Read the answer to the above question again. That should convince you. Remember, insurance is being bought to protect the financial well being of your family if you die. It is not for your well being. But if it could make you feel any better, what you can do is this – Instead of buying a Rs 5 lac endowment plan for Rs 25,000, you go ahead and buy Rs 1 crore term plan for Rs 10,000. The amount you saved this way is Rs 15,000. Right? Invest this amount every year in equity funds. Chances are high that the total value of your investment after several years (like 20-30 years assuming that is your insurance policy tenure) will be much higher than what your Rs 5 lac endowment plan would give on maturity. And what more, all this while you had a big cover of Rs 1 crore as you bought the term plan. You get the best of both the worlds.
Q4: How much term insurance cover should I take?
A4: It is quite popular to go by thumb rules and take a sum assured of 15-20 times your current annual income. So for example, if your annual income is Rs 10 lac, you can buy a cover of about Rs 1.5 crore. But it’s better to not go by thumb rules alone and instead calculate it correctly. You can refer to this detailed post that I have already written on this topic – How to calculate the right life insurance amount?
Q5: How to decide the Right tenure of the Term Plan?
A5: Under most circumstances, an insurance cover may not be required much beyond retirement. And that is simply because most of your financial goals will be over by then and you would also have accumulated enough money to take care of your dependents (mostly spouse) if you were to die. So if you are 25, then you can take a cover of 35-years which covers you till you turn 60. But if you are 38, then even a 22-year term plan will be sufficient. Shorter the tenure, lower the premium. But if you want to be conservative, you can opt for a slightly longer tenure than what is necessary and just stop paying the premium when the need for insurance is not there. You can refer to this detailed post that I have already written on this topic – How to find the right tenure for the term life insurance policy?
Q6: Term plans are cheap no doubt. But why are online term plans cheaper than offline ones?
A6: When a term plan is purchased online, the costs incurred by the company are less, as there is no middleman between you and the insurance company. This lowering of cost is passed on to you as lower premium as no commission has to be paid to any agent. Most companies offer online versions of their term plans. If you are looking to buy the best online term plan, be sure to do your research and compare across insurance providers and then make the final decision.
Q7: Is the premium of term plans same for everyone?
A7: No. It varies for everyone as it depends on the person’s age, chosen policy tenure, the sum assured, payout method opted for and other premium loadings (if any) due to medical or lifestyle reasons.
Q8: Does the premium of the term plan change during the policy tenure?
A8: No. It remains the same.
Q9: If I die, are there different options in which the sum assured gets paid out to my nominees?
A9: Yes. Insurance companies allow you to chose how the money is paid out to the nominee in case of your death. Suppose you take a term plan of Rs 1 crore. Now if you die, the money can be paid out as any of the following (depending on what you have chosen):
Full Rs 1 crore paid at the time of death
Rs 10 lac paid at the time of death. Remaining 90% (i.e. Rs 90 lac) paid out equally as Rs 50,000 monthly (0.5% of sum assured) for next 15 years
Full Rs 1 crore paid at the time of death. Additionally, Rs 50,000 paid monthly (0.5% of sum assured) for the next 15 years
Full Rs 1 crore paid at the time of death. Additionally, starting with Rs 50,000 monthly (0.5% of sum assured) and increasing by 10% every year paid out for the next 15 years
And there can be many other options depending on what the insurance provider is offering at that time.
Obviously, the premiums charged in each variety would be different. Which one should you chose depends on your need. If your nominees know how to manage a large amount to generate regular income, you can go for simple 1st option. But if you feel they are better of receiving money regularly, then probably you can go for 2nd option (or even the 3rd or 4th option which will have higher premiums). You can even have 2 separate policies with different versions chosen for payout in case of death.
Q10: Should I opt regular premium or single premium?
A10: You can choose either. In regular, you pay premiums every year. In single premium, you premium once and never again. But let’s say you buy a 25-year term plan and die after 5th year. Now if you have taken the regular premium route, then you would only have paid 5 small premiums. But if you had opted for the single premium, then you would have paid in one go and that potentially means that the 20 premiums got paid extra as you died early. Nominee gets the same amount irrespective of what you chose. But I think that’s too small an issue to bother about. You can actually do whatever you feel comfortable with. Some people want to just tackle it upfront (via single premium) and be done with it. Others don’t have a lot of surplus money to do it so prefer regular route. Whatever works for the buyer.
Q11: Does it make sense to buy term plans early or I should wait for some time?
A11: The premium amount increases with age. So earlier you buy, better it is. Also, with passing age, it’s possible that you may unluckily develop some disease that might make it difficult to get a policy later on. So don’t wait too long to buy a term plan later on. Buy it as soon as possible even if it seems too early to do so.
Q12: Does the term plan pay out even if I die in an accident?
A12: Yes.
Q13: Wouldn’t a Rs 10-20 lac term plan cover be enough for me?
A13: No. Don’t be penny-wise pound-foolish. Simply answer this question – If you die today, will your family be able to maintain their lifestyle, pay for children’s higher education, pay off loans and live well for decades to come in just Rs 10-20 lac? The answer will be a big No. So take a plan that takes care of all the above things. You can refer to the earlier mentioned post (about the same question) – How to calculate the right life insurance amount?
Q15: I want to take a term plan of bigger amount, say Rs 2 crore. Should I split it?
A15: You can do it. But keep it limited to 2-3 policies max. Better limit it to just 2. If you die, your family will have to run around to get all the policies paid out. So think from that perspective.
Q16: What if I am outside India if I die? Will it still pay money to my nominees?
A16: Yes. In most cases. Unless you go and die in a country that is on the unsafe list of the insurance company. So check the list before choosing a country to go and die!
Q17: I want to buy a term plan. But I have a health condition (or family’s health history is odd). Should I hide this information?
A17: Please don’t hide any such information. Death claims can be rejected if the insurance company finds out that you had hidden any critical information. So don’t do it. This may result in slight loading of premiums (increase in premium) that you have to pay. I think that’s much better than having a hanging sword of the possibility of claim rejection in case of death. Be willing to accept the loading of the premiums and move on with it.
Q18: I have few existing insurance policies. Should I disclose them while buying term plans?
A18: Yes. Don’t hide these either. There is nothing bad in having previous insurance policies.
Q19: I have purchased the term insurance. Now what?
A19: Tell your nominees about it. They should be aware of the policy in case you die. Only then they can claim the amount. Isn’t it?
Q20: Anything else?
A20: Stay healthy and try not to die. Your family will get the money if you die. But that’s not an ideal scenario. Isn’t it?
I hope that if you or someone was looking to answer – How to buy the right term life insurance policy? – then they found this article useful.
But time and again I have seen people overestimating these tax benefits. Why?
Because the tax benefits available on home loans are capped. So depending on the home loan they take, the actual benefit may not be as large as what many borrowers think.
Now there are 2 components of a home loan – principal and interest. And the home loan EMI also has the same two components – (i) principal repayment, and (ii) interest payment.
Deduction of up to Rs 1.5 lac for principal repayment under Section 80C of the Income Tax Act.
Deduction of up to Rs 2 lac for interest payment for self-occupied property under Section 24 of the Income Tax Act. The interest payment of up to Rs 2 lac is available as loss under income from a let out property
Additional deduction of Rs 50,000 on interest payment, over and above the deduction claimed in Section 24 is available for the first time home buyers under Section 80EE.
Tax Benefits on Home Loan Principal Repayment
A deduction of up to Rs 1.5 lac is available for principal repayment of home loans under Section 80C of the Income Tax Act.
There are few things to note here.
First, Section 80C’s tax savings are also applicable on your investments in EPF, PPF, ELSS (Equity Linked Savings Scheme) and expenses like insurance premiums, school fee, etc.
So all these investments and expenses compete with home loan principal repayment for the Section 80C benefits. Chances are high that the sum of EPF + PPF + ELSS + insurance premiums + Home Loan Principal repaid will be higher than Rs 1.5 lac. If that’s the case, the cap of Rs 1.5 lac in Section 80C limits the benefit to just Rs 1.5 lac irrespective of what you claim from within EPF, PPF, ELSS, premiums or home loan principal repayments.
Even if you have a big loan and are repaying more than Rs 1.5 lac of home loan principal, the tax benefit is limited to just Rs 1.5 lac.
Tax Benefits on Home Loan Interest Payment
Deduction of up to Rs 2 lac is available for interest payment for self-occupied property under Section 24 of the Income Tax Act. And the interest payment of up to Rs 2 lac is available as a loss under income from a let out property.
This is where things get interesting and people get confused.
Due to the above-mentioned capping of benefit, even if you are paying more than Rs 2 lac interest in a given financial year, the excess interest above Rs 2 lac will not fetch you any tax benefits.
As you can see, in total Rs 3.91 lac is paid in EMIs in 1st year. Out of this, principal forms only Rs 61,633 whereas interest is Rs 3.29 lac. Out of this Rs 3.29 lac, only Rs 2 lac is eligible for tax benefits under Section 24. The remaining amount (can be seen in red-colored text) cannot get tax benefits.
The home loans are structured like this that during initial years, a major part of your EMI goes towards interest payment. So it’s possible that the interest you pay in the initial years will be much higher than Rs 2 lac (the limit for tax benefit).
Let’s take another example to find out another interesting aspect.
We compare two loans. First of Rs 25 lac and the second of Rs 50 lac. The loan tenure and interest rate on both are 20 years and 9.5% respectively. The EMIs are Rs 23,303 (for Rs 25 lac home loan) and Rs 46,607 (for Rs 50 lac home loan).
Now have a look at the table below:
For the Rs 25 lac loan, the interest part that misses out on tax benefit is very small (Rs 35,616 in the first year and goes on reducing). But for the Rs 50 lac loan, you initially pay Rs 4.71 lac as interest in the first year. This is much more than the Rs 2 lac per year limit. So you only get the tax benefit on Rs 2 lac of interest (under Section 24). The remaining Rs 2.71 lac doesn’t get any tax benefit.
And if you focus on the table (on right) of Rs 50 lac loan, you will see that you keep having an interest component that misses out on tax benefits till the 15th year. And more interestingly, during the first 7 years of loan repayment, the tax benefit on interest payment of Rs 25 lac loan is the same as tax benefit on Rs 50 lac loan!
So much so and hue and cry for home loan tax benefits. 🙂
This is all the more reason why one needs to look at the tax angle when planning to prepay home loans. And if that wasn’t enough, there is also the dilemma of whether to invest vs prepay home loan – to benefit from higher returns elsewhere as compared to low post-tax home loan interest rates that are prevalent in India.
But I suggest that before you decide to prepay your home loan, you run your own numbers or get in touch with an investment advisor to help you out.
And if you are one among those who are still deciding whether to take a home loan or not, then I suggest that even before you begin your search for home loans online, some time should be spent to understand how home loans actually work and how best you can manage home loans once you take them.
The idea of doing this post was to highlight that at times, people get over excited when it comes to tax benefits from their home loans.
It is quite possible that you may not even get as much tax benefit as you thought you would be getting from your home loan.
Everybody wants to become financially independent. But very few actually get there.
Why?
There can be various reasons but I think that achieving something like Financial Freedom doesn’t just happen. It requires one to have a serious plan and more importantly, then commit to that plan. And that’s easier said than done.
If you were to ask me why then I will quote Charlie Munger – I did not intend to get rich. I just wanted to get independent.
And that for me is a goal worth having. But let’s not discuss my thoughts. I have already written about it in detail at F.I.R.E.
Let’s rather talk about you.
If you are beginning to get comfortable with the whole idea of financial independence or early retirement, then I am sure you would be wondering How much money do I need to Retire Early In India? Or how much is enough for Financial Independence & Retire Early (FIRE) in India?
It would be best to have a perfect formula for financial independence.
But there isn’t any.
Getting the right amount for regular retirement is a tough nut to crack in itself. And here, we are talking about early retirement. 🙂
But there are thumb rules that can get you going.
A popular one is – having a corpus equal to atleast 25 times your annual expenses.
This may be enough for some people but may not be for many others. For some 30X or 40X may be a more appropriate size. It depends on a variety of factors like current age, age of early retirement, life expectancy assumption, inflation % assumption before and after retirement, return estimates before and after early retirement and several other more serious factors like the sequence of returns risk, etc.
But as I said, if you are just beginning your journey – then the exact accuracy doesn’t matter and you can have atleast some target in front of you – which I think is a good one provided by the 25X, where X is your annual expenses.
You will, in any case, require several years to reach that first. 🙂 So relax about the accuracy a bit.
But as you get closer to your goal and/or the portfolio size grows, you need to run numbers more carefully and have additional buffers to make your early retirement plan more robust. And if it sadly means delaying it by a few years or saving more, then so be it. Better be safe than sorry when you are older.
So 25X is a good aim to have.
But what about the ‘secret’ that I mentioned in the title of this post?
Here it is…
If the X (i.e. Annual Expense) is small, you can save more and, in turn, reach the target of 25X faster.
Read that again.
And again if you are still unable to understand its importance.
Let’s take a small hypothetical example to make this idea crystal clear:
Suppose your annual income is Rs 12 lac. And your annual expenses (i.e. X) are Rs 8 lac.
So if we were to use the 25X thumb rule, then you would need 25 times Rs 8 lac – which is Rs 2 Cr as Early Retirement Corpus. And to achieve it, you will have Rs 4 lac every year (Rs 12 lac income minus Rs 8 lac expenses) to save for the goal.
Note – I have ignored inflation, etc. for simplicity here.
Now remember what I said earlier – If the X (i.e. Annual Expense) is smallER, you can save more and in turn, reach the target of 25X faster.
So let’s make the X a little smallER.
Your annual income is Rs 12 lac. And your smallER annual expenses (i.e. X) are Rs 6 lac (reduced from Rs 8 lac earlier).
Now if we use the 25X thumb rule, then you would need 25 times Rs 6 lac – which is Rs 1.5 Cr as Early Retirement Corpus. And more importantly, to reach it you will have a higher Rs 6 lac every year (Rs 12 lac income minus Rs 6 lac expenses) to save for the goal.
So the target has reduced from Rs 2 Cr to Rs 1.5 Cr. And you also have a higher amount of Rs 6 lac per year (instead of Rs 4 lac) to save for the goal.
So it’s a double benefit of having a reduced target and higher savings capability.
Decreasing your expenses (I know its tough) increases the potential to increase the savings – this fact alongwith lower target requirement can potentially accelerate your plan to reach the final corpus earlier.
Think of it like this – If your expenses are low, you will need a smaller corpus to support it for years to come. And a smaller corpus means that you will require a lesser number of years to achieve it. But if your expenses are high, then not only will your required corpus would be high, but it will also require more time and probably a higher saving rate.
And this is the real secret!
Remember – this 25X figure is just a thumb rule.
And you also need to understand the risks that such thumb rules or any early retirement plan is exposed to – like sequence of return risk, unexpected and unplanned expenses, living longer than you estimated(!), extremely high inflation in retirement years, high medical expenses inflation that isn’t covered by your health cover, etc.
The actual number will be different for different people and circumstances.
The idea here was to show that higher your saving rate, the sooner you can potentially retire.
If you save just 10% of your income, then you can forget about early retirement. You need to save a lot more – like 30, 40 or even more than 50%. I am able to do more than 50% as I aim to achieve financial freedom by 40. Fingers crossed. 🙂
So that was about the simple thumb rule for computing how much money do I require for financial independence and early retirement (FIRE).
I like to talk about financial independence on Stable Investor quite regularly. It is one of the big financial goals I have. But I must also warn you – the maths of FI is such that you can speed up the theoretical goal achievement if you reduce expenses by a lot. But then, that would mean you are sacrificing your present for the future, which is good to an extent but not beyond it.
Financial independence is a difficult goal which most people won’t achieve.
But even if you were to achieve it partially, even then it would provide you with a lot of control over your financial life. A solid early retirement corpus with reasonable return expectations will cover basic living expenses for longer than your life expectancy. That’s a good achievement no matter when you achieve it.
At the same time, I recognize that not everyone is eager to achieve early retirement. And there are also people who like their luxuries. And that is fine as it gives them happiness.
The bottom line is that your goals are unique and you need to do what is necessary to achieve your financial goals. If financial independence is not one of them, then you can ignore it. But if it is and it’s more than a passing wish, then you need to do something about it. The independence that a big corpus provides is amazing. It even gives you that magical ability to say F*** Y** to anyone without thinking too much about the consequences. 🙂
Imagine that kind of freedom!
So if you are planning early retirement in India, then sit up and take action. Just wishing and asking questions like how much money I need to retire early in India will not be enough.
