PPF vs NSC - How to Decide?

Among all the tax-saving instruments under section (u/s) 80C, ELSS occupies the numero uno position (for details, please read “ELSS: The Best Section 80C Option”) but the ELSS schemes are inherently risky. So, if you’re not comfortable investing in ELSS, you can consider PPF (Public Provident Fund) or NSC (National Saving Certificate). Among the assured return schemes, both PPF and NSC occupy the top slot.

But, the next question is: How to decide which – PPF or NSC – is better among the two? Or, which is the best tax-saving instrument under section 80C among the assured return schemes? Therefore, this article attempts to resolve the classic dilemma: NSCs vs. PPF. Let’s compare them on various parameters:

PPF vs. NSC – A Comparison

1. Returns
While PPF offers 8% per annum (p.a.), NSC offers 8% per annum compounded half yearly i.e., the effective yield is 8.16% per annum. Not a big difference.

2. Tax on returns
PPF returns are tax-exempt but NSC returns are taxable. Interest accrued on NSC is to be included in your total income every year.

However, you’re also entitled to get the deduction under section 80C for the interest accrued on NSCs, because this notional interest is deemed to be reinvested. So, the net effect is that your section 80C limit gets reduced to that extent because otherwise you would have made investment in other tax-saving instruments to the extent of accrued interest on the NSC. If your section 80C limit already stands exhausted, then your post-tax returns from NSC would become 6.48% if you fall in 20.6 per cent tax bracket and 5.64% if your marginal tax rate is 30.9 percent.

3. Whether returns are guaranteed/ fixed
Once you invest in a NSC the interest rate gets locked-in i.e., can’t be changed subsequently, where as in case of PPF the returns are assured but not fixed. In other words, depending upon the interest rate scenario, government can move it either downward or upward, as the economic situation demands.

However, as the interest to your PPF account gets credited every year, the change in interest rate is always prospective and not retrospective.

Let’s see the past changes in the PPF interest rates:

From 1986-87 to 1999-00 -> 12.00%
2000-01 -> 11.00%
2001-02 -> 9.50%
2002-03 -> 9.00%
Since 2003-04 -> 8.00%

Now, let’s see the past changes in NSC interest rates:

Mar’01 to Feb’02 -> 9.5%
Mar’02 to Feb’03 -> 9.0%
Mar’03 onwards -> 8.0%

From the above mentioned changes in PPF and NSC interest rates, we notice that PPF and NSC interest rates are changed simultaneously, so that both are at par (with a slight difference due to half yearly compounding in case of NSCs).

However, what makes the yield differ is the fact that in case of NSC’s revised rates applies only for new purchases, while for PPF new interest rates apply to all accounts, both new and existing. For instance, let’s say you invested Rs 1000 each in both PPF and NSC in March 2001. Now, while for NSC you would have received interest @ 9.5% per annum (compounded half-yearly) for all the 6 years of it’s duration, your PPF account would be credited with interest @ 9.5% for only the year 2001-02 and for subsequent years reduced interest rate would apply (i.e., 9% for 02-03 and 8% since 03-04 onwards).

4. Liquidity
While the duration of NSC is 6 year, PPF carries a lock-in period of 15 years. Besides, PPF premature account closure is not permissible except in case of death. Although partial withdrawals are allowed from the PPF account from seventh year onwards, the actual amount depends on the balance in the account in earlier years. Thus, NSCs offer better liquidity than PPF.

5. One time or regular investment
While NSC requires one time investment, PPF requires regular investment. NSC is the form of a certificate but PPF is in the form of an account and to keep it active, you’ve to make regular investment – a minimum amount of Rs 500 has to be deposited every year to keep the account active.

So, except the parameter of ‘taxability of returns’, on all other counts the NSCs score over PPF. However, this singular factor is big enough to tilt the balance in favour of PPF. Let’s see:

1. If the tax-saving limit of Rs 1 lakh under section 80C remains under-utilized year after year, then NSC, no-doubt, is the best option for you because in that case net tax effect (of NSCs accrued interest) is zero. In other words, in such a case, NSCs returns also become tax-free.

2. If your existing tax saving investments exceeds the limit of Rs 1 lakh (or expected to cross the Rs one lakh mark, in the near future) as specified under section 80C, then it would have direct impact on your post-tax returns from NSCs ; for example, it becomes 5.64% if you fall in the 30.9% tax bracket. In such a case it is better to opt for PPF. However, even in such a case you should opt for NSC if your investment horizon is medium term (i.e., you’re going to require the money, say, after 6 or 7 years for your spending needs).

No doubt, the liquidity factor and uncertainty associated with the PPF interest rate are two major drawbacks.

However, if you just change your perception and give it another look, lack of liquidity should not be a hindrance. Perhaps, it’s a blessing in disguise. Why? Because even if you get back your money, say, after 3 years or 6 years, won’t you invest it some where else or spend it on some worthless things.

So, if you invest your funds for different time duration according to your financial plan/ needs and invest only so much in PPF which you can spare for long term, 15 years lock-in period should not be a constraint. In other words, for the purpose of saving money for long term goals, like education and marriage of children or to save for retirement – which you must – PPF is the best debt instrument after EPF (Employees Provident Fund).

Besides, in emergency cases, if you require the funds before the maturity, the option of making partial withdrawals, or borrowing against your PPF account, is always available.

As regards the uncertainty associated with the PPF interest rate, we can observe that since 2003, there has not been any change in the PPF interest rates. Even if there is a change in near future, in my view, it can’t go beyond +/- 1%.

I hope the above discussion is helpful to you in resolving the dilemma between PPF and NSC. However, if you’ve any further suggestion or questions, please feel free to leave a comment.

Finally, if you've decided to invest in PPF, please read "How to Invest in PPF-10 Practical Tips".

Also see:

1. Making the Most of Section 80C - 10 Smart Tips
2. Ulips vs Traditional Insurance Plans: Which is Better?
3. Direct Stock Investment vs Mutual Funds
4. Section 80C Tax Saving Options
5. Claiming HRA Tax Exemption - Tips & FAQs
6. Best Ulips based on IRR

How to Claim HRA Tax Exemption - Tips & FAQs

First, let me clarify that for claiming HRA (house rent allowance) the correct word is EXEMPTION and not DEDUCTION. What’s the difference between exemption and deduction? Well, exempt portion of HRA is not considered as part of the taxable income whereas in case of deduction first the amount is included in your gross total income (GTI) and afterwards the deduction is allowed.

For example, while the persons drawing salary receives HRA , which gets TAX EXEMPTION under section 10 (13A) of Income Tax Act, 1961 read with rule 2A of Income Tax Rules ; the self-employed persons are entitled for TAX DEDUCTION under section 80GG of Income Tax Act, 1961.

Here we discuss some tips and frequently asked questions (FAQs) relating to HRA tax calculations and claiming exemption:

Calculating HRA Exemption

1. How to calculate HRA? Or, how much HRA is exempt from tax?
Please READ “How to Calculate HRA Income Tax Exemption”.

2. Whether HRA calculation to be done on monthly basis or annual basis?
There are four variables in HRA tax calculations: namely, salary (i.e., basic pay plus DA), HRA received, rent paid and the city of residence (whether metro or non-metro). In case all of the four remain the same through out the year, the HRA tax exemption calculation is to be done on ‘annual’ basis. On the other hand, if there is a change in any of the variable during the year then HRA tax exemption calculation is to be done on monthly basis.

3. What if the place/city of residence and place/city of working is different?
Good question. In such a case for the purpose of HRA calculation, place of residence will be considered and not place of working. Suppose that you’re working in a factory or a company located in Sonepat (near New Delhi) while residing in New Delhi. So, for the purpose of HRA, your maximum entitlement for tax purpose will be 50% of the basic instead of 40% because for metros HRA tax entitlement is 50% and for non-metros it is 40%.


Claiming HRA Exemption

4. How to Claim the maximum possible tax exemption on HRA?
Yes, indeed it is possible to claim the HRA tax exemption to the maximum extent possible as provided in the income tax law. For details, please read “How to Claim Maximum HRA Tax Exemption”.

5. How can a self-employed person claim tax benefit for the rent paid?
As the self-employed person doesn’t receive any salary, so there is no HRA and consequently question of HRA exemption – under section 10 (13A) of Income Tax Act, 1961 read with rule 2A of Income Tax Rules –doesn’t arise.

However, to take care of such a situation, there is a separate provision in the Income Tax Act, whereby a person not in receipt of HRA but incurring rent expenses for his residence can claim a deduction under section 80GG which is quite similar to section to 10(13A) but some additional conditions have been imposed.

6. Is it possible to claim HRA as well as home loan tax benefits?
Yes, certainly. There is no relationship between claiming HRA exemption and claiming interest deduction for housing loan. For details, please go to “4 Ways to Claim HRA exemption and House Loan Interest Deduction”.

7. What if the employer refuses to allow the HRA tax benefit?
Nothing to worry about. Just claim it while filing your return of income and get the refund of excess TDS deducted from your salary. But, first try to convince your employer and clarify his doubts, if any, regarding your eligibility for claiming it. If your case is indeed genuine, I don’t think your employer should have any problem in allowing HRA tax exemption.

8. Is it possible to claim HRA if residing in a relative’s (Parents/Spouse) house?
Please read "4 Ways to Claim HRA exemption".

9. Can both the working spouses claim HRA tax benefit separately?
Yes, Why not? If both of them are paying rent and landlord issues either two separate rent receipts or only one receipt specifying the amount or proportion paid by each, then both husband and wife are entitled for HRA exemption according to the amount of rent paid.


Submission of Evidence

10. What evidence needs to be submitted for claiming HRA?
The only evidence required for claiming HRA tax exemption is proof of rent payment (i.e., the rent receipt issued by the landlord). A lot many people think that you also require rent agreement for claiming HRA tax exemption but there is no such requirement in tax laws.

Furthermore, even the requirement of production of rent receipts have been dispensed with for the salaried employees drawing HRA (house rent allowance) up to Rs 3,000 per month. Please note that this relaxation is only for the purpose of TDS on salary and in the regular assessment, tax assessing officer has the power to ask for the relevant evidence, if deemed necessary.

Besides, please carefully note the above limit of Rs 3,000 is for the amount of HRA received per month and not for the amount of rent paid. For example, if you’re drawing a monthly HRA of Rs 4,000 p.m. but paying a rent of Rs 2,500 per month, you’ll have to submit the rent receipt for claiming HRA.

11. Can we submit rent agreement instead of rent receipt for claiming HRA?
Yes, if you wish you can submit the rent agreement but it can be in addition to and not instead of the rent receipt.

It’s quite possible that you’ve entered into a rent agreement but not paid the rent. The evidence of actual payment of rent is only the rent receipt and not the rent agreement. Thus, at present the only documentary evidence required for claiming HRA is rent receipt.

12. Whether PAN no. of landlord needs to be mentioned on rent receipt?
No, there is no such requirement under the tax law.

13. Whether all the 12 months rent receipts need to be submitted?
Absolutely not! The basic purpose is to satisfy the DDO that you’re actually paying the rent. It will suffice if you submit rent receipts for 2 months – one for the start of the financial year (i.e., April) and other one for the end of the financial year (i.e., March), or at the most 3 months (third one for the middle of the year).

14. Is there any particular format for rent receipt?
No particular format for rent receipt has been specified under the income tax law. However, a typical rent receipt can be as follows:

Received a sum of Rs ------vide cheque (no.-------dt------) or cash, being the rent for the month/period of ----- from Mr./Mrs.----- in respect of House no----(Mention complete address).

Date:-------
Place:------

Signature of
Landlord
(Name of Landlord)

It can also be in a different wording, but please ensure it mentions the following relevant information:

a) Amount of rent paid
b) Period/month
c) Mode of payment (Cheque/Cash)
d) Your name
e) Landlord’s name
f) Landlord’s signature
g) Residential address
h) Date & Place
i) A revenue stamp of Rs 1 for payment (both cash/cheque) exceeding Rs 5,000.

I hope that above tax planning tips and Faqs are able to answer your queries regarding calculating and claiming HRA income tax exemption. However, if you still have any doubts, or if there are any unanswered questions, please feel free to ask here in the comment box. I’ll try my best to clarify them.

Also See:

1. HRA Tax Calculator

2. How to Calculate HRA Tax Exemption

3. 4 Ways to Claim HRA with Home Loan Tax Benefits

ULIPs - 10 Top Most Factors to Know About

It’s tax-planning season again. During the last quarter of a financial year (January to March) the most talked about topic especially in office corridors is the tax saving under section 80C of the Income Tax Act. The first and most obvious choice of people is life insurance. And among life insurance products, the most popular policies are Ulips. To know, whether the decision to invest in life insurance as a tax saving tool is correct or not, please read “Section 80C - 10 Smart Tips”. In this article, the topic of discussion is some known and unknown top most factors about Ulips.

Here are the 10 Top Most Factors or things to know about ULIPs:

Good Factors

1. Top most fact about Ulips – Insurance cum Investment products
Ulips are insurance cum investment products and only way you can benefit from them is to consider them as long term financial products with a minimum tenure of 10 years.

While buying Ulips, insurance should be your most important consideration and investment should be the secondary motive.

2. Top most misconception about Ulips – Only equity linked
The most common myth about Ulips is that they are linked only to equity markets.

The fact is that there are various fund options (differs from company to company) available in case of Ulips. However, we can broadly categorize them into three types – 100% equity fund, balanced fund and 100% debt fund. There are also various other fund options available with varying degree of equity and debt allocations.

You’ve the flexibility to choose a fund option based on your risk appetite and if you wish, you can switch to another fund option at a later stage.

3. Top most benefit Ulips offer over traditional Insurance plans – Possibility to earn higher rate of return
Unlike traditional plans which invests almost their entire money in debt portfolio, Ulips give you full discretion to invest the money the way you want.

As already mentioned above, there are various fund options available with varying degree of equity and debt proportions. Further, once invested, you’re not bound and can make subsequent changes in the fund option according to your needs and risk appetite.

For a detailed comparison between Ulips and traditional life insurance plans, please read "Ulips vs Traditional Plans".

4. Top most good (or the best) thing about Ulip – Fund Switching Option
There is nil or negligible cost involved. Besides, there is no tax involved. And most of all, it is hassle free. The day mutual funds also start providing this fund switching facility, the only real edge Ulips have over mutual funds will be lost.

5. Top most Ulips available in the market
Please see “Best Ulips Based on IRR And Expense Ratios”.


Bad Factors

6. Top most reason for Ulips popularity – Large scale financial illiteracy
Undoubtedly, the most important reason behind Ulips popularity is that most of us don’t know what is life insurance and why and how much we need it?

The secondary reasons behind their popularity are—Ulips are better than traditional life insurance products and also the exceptional stock market returns during 2004-07.

7. Top most flipside of Ulips – Riskier
Ulips are more risky than traditional life insurance plans. Actual risk depends upon the fund option chosen by you; greater the equity component, higher the risk. As the investment risk is borne by you, in case of a market down turn, you might have to bear huge losses. Just try asking someone who has invested in Ulips during the last few years.

8. Top most hidden factor about Ulips – IRR
IRR (Internal rate of return) is the major factor which is kept under wraps by the life Insurance companies to make it difficult for us to compare one Ulip with the other. If the life insurance companies start publishing this figure it will become a lot easier even for a layman to understand and find the low cost Ulips in a manner similar to the way we compare term plans. For other hidden facts please read “Unravelling the Ulips – 5 Secrets You Should Know About”

9. Top most bad (or the worst) thing about Ulips – The way they’re sold
Instead of selling Ulips as the long term life insurance products, advisors sell them as short term investment plans with tax incentives.

10. Top most reason to invest in Ulips – If you’re not financially savvy
Go for Ulips, if you’re not financially savvy and can’t separate your insurance needs from your investment and tax planning goals.


Also see:

1. SBI Life-SMART ULIP: Review
2. Life Insurance - Top Most Amazing Fact
3. Section 80C - 10 Smart Tips
4. Section 80C - Various Tax Saving Options
5. 5 Secrets about ULIPs
6. Tax Calculator

How to Claim Maximum HRA Tax Exemption

So, by now you know How to Calculate HRA Tax Exemption and also 4 Ways of Claiming HRA either solely or along with home loan interest tax deduction.

But, do you know how to claim maximum HRA tax exemption or deduction? Well, here we deal with two such basic questions:

First, how to design CTC (cost-to-company) package so that the HRA component of the CTC is the maximum allowed by the I.T.Act and one can claim the HRA tax exemption to the maximum extent possible?

Second, how to claim the entire HRA received as exempt?


How to design CTC so that one can take the HRA exemption to the maximum extent possible?
While designing salary package, one should always ensure that the employer has designed it in such a way as to get the maximum possible tax benefit.

Let’s Continue with the same example as mentioned in the previous post ‘How to calculate HRA tax exemption’ where we assumed that you’re residing in Mumbai and paying a rent of Rs 20,000 per month and that your total CTC is Rs 70,000 (Basic Rs. 50,000 and HRA Rs 20,000). If you give a second look and analyze the above example, you’ll notice that the salary package is not designed in an optimum or tax efficient manner. How? What’s wrong in the above salary package?

Let’s say your rent is increased and you have started paying a rent of Rs 31,000 p.m. Rest of the assumptions remains the same. Now, the least of following three figures will be exempt:

1. HRA received i.e., Rs. 20,000
2. Rent above 10% of basic i.e., Rs. 26,000 (Rs. 31,000 – Rs. 5,000)
3. 50% of basic i.e., Rs. 25,000

The least of the three is Rs 20,000; hence, the amount of HRA exempt will be Rs 20,000 p.m. and your total taxable income will become Rs. 50,000 p.m. (Rs 6,00,000 p.a.) whereas it can be less than that.

So, what’s the catch? Actually, we have assumed that you are residing in Bombay and for that the tax law allows you to receive a maximum amount up to 50% of the basic salary as HRA whereas in the above case study your employer is allowing you only 40 per cent of the basic as HRA.

Now, you’ll ask if the employer changes the CTC pay package and increases the HRA component of the package to 50% of the basic, won’t the CTC gets increased. Yes, surely the CTC will increase but there is other way around. Your total CTC is Rs. 70,000 comprising just basic plus HRA (with no other allowances or benefits as assumed) and second condition is the HRA should comprise 50% of your basic. It’s simple maths; just divide your total CTC with 1.5 and you’ll get the basic part and multiple the basic with 0.5 and you’ll get the HRA part. So, here we arrive at a basic of Rs. 46,666 and HRA of Rs 23,334. Now, just recalculate the HRA tax examption, you’ll find the entire revised HRA of Rs 23,334 is exempt and your total taxable income reduces from Rs 6 lakh p.a. to Rs 5.60 lakh p.a.

Thus, in the above case study, by changing your salary structure and molding it according to tax laws, increases your HRA tax exemption from Rs 20,000 to Rs 23,334 the maximum allowed under the Income Tax Act.

In a nutshell, make sure that your company provides 40% or 50% (depending on the location) of the basic salary as HRA to make your CTC tax efficient.


Is it possible to claim the entire amount of HRA received as exempt?
Yes, why not? If the actual rent paid by you exceeds the HRA received by an amount equivalent to 10% of the basic (+DA), then the entire amount of HRA gets exempted. Put another way, if you want to claim the entire amount of HRA as exempt, then you should be paying a minimum rent of 60% of your basic pay for metros and 50% for non-metros. But the exemption can’t go beyond that even if you’re actually receiving more HRA, say, 70% or 80% of your basic as part of your salary package.

Please also note that it’s possible to get the entire HRA received as exempt but it’s not possible to get the entire amount of rent paid as exempt. In other words, rent paid up to an amount equivalent to 10% of the basic (+DA) is always included in your income irrespective of the actual amount of HRA received and rent paid by you.

If you've any other question or query relating to HRA, please read "How to Claim HRA Tax Exemption - Tips & FAQs".

Also see:

1. HRA Tax Calculator

2. How to Calculate HRA Deduction

3. 4 Ways to Claim HRA with Housing Loan Tax Concessions

Best ULIPs based on IRR and Expense Ratios

Ulips (unit-linked insurance plans) are considered as one of the most complex financial products but it is not without any reasons. They combine the features of both mutual funds and insurance. First you have to choose the premium and the sum assured, then there are various fund options to choose from ranging from pure equity to pure debt.

But the main factor responsible for their complexity is the difficulty in comparing one ulip with the other due to varying charges--such as mortality, premium allocation, administration and fund management--levied in a different manner by different insurance companies. Some charges are deducted on annual basis and others on monthly basis. While some charges are based on premium amount, others are based on either the sum assured or on the fund value or on the type of fund option chosen. Some of the costs are deducted by cancellation of the units, others are deducted from the premium paid and still others are adjusted from NAV itself. Some are levied on flat basis and others are levied on per cent basis. Some charges are deducted only in the initial few years while others are levied during the entire tenure.

So many different charges, applied differently over different tenures by different insurance companies having different Ulip plans. Just Confused? So, how to make sense of all this? How to combine all of these charges together into one figure?

Well, here IRR (internal rate of return) comes to your rescue. However, even though all the way we keep on shouting that the best way to compare Ulips is to know their IRR, but it is well-nigh impossible for an uninitiated to do all these complex financial calculations him self or her self and arrive at IRR and expense ratios.

But nothing to worry about because since last year Outlook Money has initiated an effort to rank the Ulips based on cost and return parameters. First rankings were published in December 2007 and second one in December 2008.

As per the latest rankings of Ulips by the Outlook Money, following are the Top 10 Type I Ulips based on IRR:

1. Birla Sun Life--Classic Life Premier (8.07%)
2. Aviva Life-- Freedom Life Plan (7.82%)
3. AEGON Religare Life--Protect Gain (7.76%)
4. Kotak Mahindra Life--Long Life Wealth Plus (7.69%)
5. ING Vysya Life--High Life (7.62%)
6. Future Generali Life--Future Sanjeevani (7.58%)
7. TATA AIG Life--Invest Assure Flexi (7.42%)
8. IDBI FORTIS--Wealthsurance (7.42%)
9. MetLife-- Smart Gold (7.33%)
10.Reliance Life--Market Return (7.32%)

And here is a list of Top 10 Type II Ulips based on IRR:

1. Kotak Mahindra Life--Platinum Advantage (7.55%)
2. Birla Sun Life--Supreme Life (7.50%)
3. ING Vysya Life--High Life Plus (7.37%)
4. ICICI Prudential Life--Life Stage RP (7.18%)
5. ICICI Prudential Life--Life Stage Assure (6.98%)
6. Aviva Life--Life Saver Plus (6.82%)
7. Bajaj Allianz Life--New Family Gain (6.71%)
8. SBI Life--Horizon II (6.66%)
9. Aviva Life--Life Save Super (6.61%)
10.Birla Sun Life--Saral Jeevan (6.13%)

The above rankings by outlook money are based on assumed rate of return of 10% (the highest return allowed by IRDA for illustration purposes) and further assuming investment in 100% equity fund. Besides, the top 10 in type I category are out of total of 32 schemes ranked. In type II category there were only 10 schemes; therefore, all of them have been mentioned here.

But, what is actually meant by IRR of, say, 8.5% or 8%? And how does it make the difference in the returns you receive from Ulips?

An IRR of 8.5% means that if in the future the fund is able to generate a gross or total return of 10 per cent, the 1.5 per cent portion will be eaten away by all the expenses taken together and you’ll be left with a net return or net yield of 8.5%. Put another way, the expense ratio of an ulip having an IRR of 8.5% is 1.5% i.e., 1.5% of the fund value (or 15% of the returns generated) which goes towards meeting various ulip expenses (by whatever name called) and you receive a real return of 8.5%.

Put simply, the gap between the gross returns (here assumed at 10%) and the IRR shows the cost of the policy. Higher the IRR, lower the cost and vice-versa.

Classic Life Premier from Birla Sun Life is the lowest cost policy in the Type-I category and Platinum Advantage from Kotak Mahindra Life is lowest cost plan in the Type-II category. However, you can consider top 5 from each category as the best Ulips based on their low cost (i.e. high IRR).

Also, the IRR difference between top most plan in Type I and Type II categories is around 0.5% meaning thereby that type II Ulips are costlier than Type I Ulips because of the enhanced protection cover offered by the Type II policies.

Now, let’s come to the second question i.e. the impact of IRR on the actual returns received by you. Suppose that you pay an annual premium of Rs 50,000 for 20 years for an Ulip which is having an IRR of 10% (assuming actual gross returns of 12% and expense ratio of 2%). Thus, at the end of 20 years, you’ll receive Rs 31.50 lakh as the maturity proceeds of your Ulip. Now, suppose that instead of 10%, your Ulip generates an IRR of 9.5%. In this case you’ll receive Rs 29.63 lakh i.e., Rs 1.87 lakh less which is quite a substantial amount. If we increase the gross returns in the above example from 12 to 15%, then the total impact also increases to Rs 2.78 lakh. Further, if we double the annual premium payment from Rs 50,000 to Rs 1,00,000, the total impact on the final maturity proceeds rises to around 5.57 lakh.

Finally, please note that Ulip rankings based on IRR or expense ratio’s is only one side of the coin. Other side is the actual returns that the Ulip fund earns. More of it in a later post.

If you're interested to gain more insights into the Ulip mystery, please read "5 Secrets About ULIPs" and "1O Top Most Things to Know About ULIPs".

Also see:

1. SBI Life-SMART ULIP: Analysis

2. 10 FAQs about ULIPs

3. Top 5 Misconceptions about Life Insurance

4. Capping of ULIP Charges by IRDA - A Review

5. Best ELSS for FY 2009-10

How to Calculate HRA Income Tax Exemption

Almost every salaried class person receives HRA (house rent allowance) as part of the salary package irrespective of whether he is paying rent or not. Besides, after basic pay, HRA constitutes the second most significant component of your CTC (cost-to-company).

From tax planning point of view, I have already mentioned in detail how to claim HRA tax exemption and also further clarified all your doubts regarding claiming both -- HRA tax exemption and home loan interest deduction -- simultaneously. For details, please see 4 Ways of Claiming HRA Tax Exemption Along With Home Loan Interest Deduction.

However, some of you might also be interested in knowing how much of the HRA is actually tax exempt or deducted while computing taxable income, or how to calculate the tax exempt portion of the HRA. In fact, it is better to be aware of some tax basics instead of completely relying on your employer so that you can do some of the basic tax calculations and planning yourself.

According to section 10 (13A) of Income Tax Act, 1961 read with rule 2A of Income Tax Rules, least of following three is exempt from tax:

1. Actual HRA received
2. Rent paid in excess of 10% of salary (Basic + DA)
3. 40% of salary (50% if residing in a metro i.e., New Delhi, Kolkata, Chennai or Mumbai)

Salary for the above purpose means BASIC + DA. However, private sector organizations, usually, doesn’t provide DA to employees.

Let’s take an example. Suppose that you’re residing in Mumbai and paying a rent of Rs 20,000 p.m. and that your salary package comprises the following:

Basic — Rs. 50,000 p.m.
DA — Nil
HRA — Rs. 20,000 p.m. (40% of basic)

Now, the exempted amount of HRA will be least of the following three figures:

1. HRA received i.e., Rs. 20,000
2. Rent above 10% of basic i.e., Rs. 15,000 (Rs. 20,000 – Rs. 5,000)
3. 50% of basic i.e., Rs. 25,000

The least of the three is Rs 15,000; therefore, in this particular case you’re entitled for HRA tax exemption of Rs. 15,000 p.m. (per month) out of total HRA received of Rs. 20,000 p.m. In other words, net taxable portion of the HRA works out to be Rs 60,000 i.e., Rs 2,40,000 (HRA received) minus Rs 1,80,000 (HRA tax exempt).

If you've any other questions regarding HRA, please read "How to Claim HRA Tax Exemption - Tips & FAQs".

Also see:

1. HRA Tax Calculator

2. 4 Ways of Claiming HRA plus House Loan Tax Benefits

Hidden Flaws of Spending - Why Do We Make Fatal Money Mistakes

“Beware the fallacies into which undisciplined thinkers most easily fall – they are the real distorting prisms of human nature”

-–Francis Bacon

Why do we find it hard to save? Economy theory explicitly assumes that people are rational decision makers - people make best possible economic choices, delay gratification in pursuit of a greater reward tomorrow, want to maximize returns, eliminate unnecessary expenditures, and save for future.

In reality, we are all emotional humans and not completely rational. Richard Thaler in his book Winner’s Curse says “…we are neither pure saints nor sinners-just human beings…”

We regularly assume that we know more than we actually do about money and routinely and repeatedly make bad decisions over money. We know how much we earn, but have no idea how much money we spend. How can we possibly manage our money, if we have no idea where it goes?

To spend less than what we make, we need to understand how much we spend, where we spend, and why we spend the way we do. No one is here to judge whether the motives behind our spending are right or wrong. However, knowing why we spend the way we do gives us a better idea, if that spending is the answer to what we really seek. The idea is not to give up everything and become a monk.

It is said that one should know the toxicity of poison before taking an antidote; thus, understanding the pitfalls inherent to our thinking is our best defense against bad spending behaviour. For treating the root cause rather than the symptoms, first we need to understand the psychology of spending (i.e., psychological factors influencing our spending).

For winning the battle of overspending, understanding the emotional factors and biases which often lead to compulsive spending habits and living beyond our means is necessary. Biases are like holes in our reasoning abilities and can impair our decision making. By developing understanding of biases that affect our buying decisions, we can avoid becoming victim to them.

Furthermore, personal finance is not just about investment and tax planning. It’s much more than that. Money management (budgeting & saving) is a vital task which is extremely important to any family’s financial future. However, after insurance, money management is the second most important but neglected area in personal finance.

Therefore, in this series of articles on money management to be published on monthly basis (starting shortly), you’ll learn the nuts and bolts of money management.

I’ll cover in detail the following topics:

1. Hidden Flaws of Spending: Individual Specific Flaws
2. Hidden Flaws of Spending: Marketing Gimmicks
3. Saving Strategy 1: How to Make Smart Buying Decisions
4. Saving Strategy 2: How to Make Lifestyle Changes
5. Saving Strategy 3: How to Become Financially Literate
6. How to do Personal Budgeting

So, STAY TUNED!

Also see:

1. Savings - A Step towards Sustainable Living

2. 10 Reasons Why You Need a Savings Plan

3. Hidden Flaws of Spending: Individual Specific Flaws (# 1)

4. Hidden Flaws of Spending; Individual Specific Flaws (# 2)

5. Hidden Flaws of Spending: Marketing Gimmicks (#1)

How to Surrender or Get Rid of Life Insurance Policy - Various Early Exit Options

Have you ever wanted to discontinue your life insurance policy?

There might be plethora of reasons to get rid of your life insurance policy – financial constraints (can’t afford to keep up with the premiums, too many life policies (want to rid yourself of unwanted life policies), non-satisfaction with the current life policy (as it was initially bought for the wrong reasons), or availability of better investment options.

Well, if you're really desirous of dumping your life insurance policy, there are various exit options available. Here is a lowdown on how to make an early exit from a life insurance policy.


Term Plans
Term plans are the life insurance contracts without savings component and are easiest to dump. You just don’t renew your policy.

As there is no money back or return obligation, the pure insurance plans don’t have any surrender value. Put another way, you’ll not get back anything if you fail to renew your term policy.


Traditional Policies (e.g., endowment, cash back, whole life)
Here there are 3 different ways to exit midway:

1. Let the insurance policy lapse
Out of various exit options, the easiest way out is to stop paying your insurance premium. In case you want to forego your policy within first three years, there is no other way but to let it lapse by not paying the renewal premium. Here you don’t get anything back and all your premiums paid go waste.


2. Surrender the insurance policy
The second exit option is to surrender the life policy. It is the voluntary termination of the insurance contract by the policyholder before the maturity. If you cancel (exit midway before maturity) the policy you get surrender value. In other words, it is premature encashment of the life insurance policy.

For traditional life insurance policies such as endowment, money back or whole life, there can’t be any surrender during the first 3 years because surrender value is nil. Even thereafter during the early stages of policy the surrender value is just a fraction of the total premiums paid. It increases as the policy moves closer to the maturity.

The guranteeded surrender value is 30 per cent of the total premiums paid subsequent to the first year. For instance, if you are paying a annual premium of Rs 20,000 then in the 5th year the policy will have minimum surrender value of Rs 24,000 (80,000*33.33%).

3. Make the insurance policy paid up
After three years of policy term, you also have another option available of keeping the policy in force without paying any further premiums. In other words, by converting your regular policy into paid-up policy you don’t have to pay any more premiums and the policy life coverage continues albeit with a reduced sum assured.

The policy automatically acquires a paid up value if it has run for minimum period of 3 years and subsequent premiums are not paid.

The reduced sum assured bears same proportion to the original sum assured as the number of premium paid bears to the total number of premiums payable. Suppose the original sum assured was Rs 10 lakh and the policy term was 20 years. Now, if you surrender the policy in the 6th year (i.e., after paying 6 annual premiums) the reduced sum assured will become Rs 3 lakh (6/20*10).



ULIPs
In case of Unit linked insurance policies (Ulips), rules are a bit different.

On surrender of an ULIP, a surrender value is payable which is usually expressed as a percentage of the fund value. In other words, fund value minus surrender charges is equal to surrender value.

As per IRDA guidelines, if the Ulip is surrendered during first three years (i.e., due premiums have not been paid for at least 3 consecutive years from inception), the insurance contract ceases immediately, but the surrender value, if any, can’t be paid before the expiry of 3 years. In other words, unlike traditional policies where the policy lapses and you don’t get back anything for surrender before 3 years; Ulips acquire surrender value even before completion of three years but that is payable only after the completion of three policy years.

But the fund value of a ULIP is too low in the initial years (due to high front end costs) and surrender value is even lower because the insurance companies levy heavy surrender charges (levied as a percentage of fund value) during the initial years which vary from scheme to scheme and progressively reduce every year.

However, most of the Ulips usually provide for full surrender of the policy after 5 years without any surrender charges. Put simply, you get the full fund value without any extra costs. But there are exceptions also. To discourage, policy holders from making premature redemptions some Ulips levy steep surrender charges even after 5 years which may even go up to 10, 15, 20 or 25 years.

Besides, unlike traditional policies Ulips also allow part surrender (i.e., partial withdrawal) after 3-5 years without any cost and without any reduction in the insurance coverage. For more details, please see, 5 hidden facts about Ulips.

Furthermore, if due to financial constraints or due to any other reason, you’re unable to pay premiums after 3 years, nothing to worry about. You can stop paying premium without surrendering the Ulip. Put another way, for Ulips, there is another option of ‘cover continuance’ available after completion of 3 policy years. If you opt for this option you can stop paying premium after 3 years and still your policy remains in force and your life insurance cover continues.

However, remember that applicable charges such as mortality, fund management and administration are automatically deducted out of fund value by cancellation of units. Besides, if the fund value falls below the one year’s premium then the policy is terminated and the balance fund value is returned (Foreclosure of policy). In other words, you can continue the policy without paying the premium till the value of investment is greater than one year’s premium.

Finally, a word of caution. For actual application of various exit options discussed above, you should carefully read the policy fine print before making the decision. And always keep in mind the adverse effects of terminating your life insurance policy.

Also see:

1. Understanding Life Insurance: Ask Yourself a Few Questions

2. 5 Common Myths about Life Insurance

3. Most Amazing Fact about Life Insurance

4. 7 Basic Features to Know about Life Insurance policy

5. Health Insurance: Practical Guide

How to Invest in Best ELSS Mutual Funds

So, I suppose that after having read the articles how to do section 80C tax planning and why ELSS is considered as the best tax saving option under Section 80C, you’re finally convinced that Equity Linked Savings Scheme (ELSS) is the best tax saving option under section (u/s) 80C and have decided to invest in it. However, before you invest your hard earned money in ELSS schemes you must understand how to invest in ELSS mutual funds.

Follow these guidelines to select and invest in the best ELSS mutual fund:

1. Choose the right fund
Once you’ve decided to invest in ELSS, it is crucial that you select the BEST ELSS fund.

Even among the ELSS category performance differs across the various funds. At present around 30 ELSS funds are available in the market. With so many ELSS funds out there, how do you know which one to choose? Which ELSS fund is the best ?

For deciding about the best ELSS scheme to invest in, you should solely go by the long term performance. To know more details about how to invest in mutual funds, please click here. The most important factor in arriving at the final decision is to consider the past performance of the various funds in addition to the credentials of the fund house. Also remember that all ELSS funds aren’t the same. While some have small and mid-cap bias, others don’t.

The best way to choose the top rated ELSS funds is to go by the mutual fund ratings published by Value Research (Monthly), Economic Times (Quarterly MF Tracker) and Outlook Money (Annual Ratings).

As per the latest rankings by Value Research, following are the top rated funds in the ELSS category:

a) Magnum Taxgain (5 star)
b) Sundaram BNP Paribas TaxSaver (5 star)
c) Franklin India Taxshield (4 star)
d) Canara Robeco Equity Tax Saver (4 star)
e) HDFC Taxsaver (4 star)
f) Principal Personal Tax Saver (4 star)
g) Sahara Tax gain (4 star)

As long as you invest in any of the 5 or 4 star rated ELSS funds, you’ve nothing to worry about. If you would like to further filter these ELSS funds on the basis of consistent top ranking over a period of time, here are the best three

a) Canara Robeco Equity Tax Saver[1 year (1/29), 3 year (2/23), and 5 year (4/19)]

b) Sundaram BNP Paribas Taxsaver[1 year (2/29),3 year (1/23), and 5 year (2/19)]

c) Sahara Tax gain [1 year (4/29), 3 year (3/23), and 5 year (6/19)]

1/29 means that the scheme stood first out of 29 ELSS schemes and similarly 4/19 means that relative rank of the scheme was 4th out of total of 19 ELSS schemes.

Also remember to put your money in one ELSS fund or at the most two. Don’t spread it across too many funds.

UPDATE [Dec 7 2009]: For latest list of best tax saving funds see: Top ELSS for 2009-2010.

2. Minimize the risk
By now, you've selected the best ELSS fund. However, your job is not over. As you already know, the risk level of ELSS is higher compared with other tax saving instruments under section 80C.

Therefore, second consideration to be kept in mind while investing in the best ELSS is that equity markets are volatile and subject to market risks. To minimize the risk you should invest in small amounts on regular basis spread over the entire financial year rather than investing a big chunk at the end of the year. If you’re not disciplined, you can enroll for systematic investment plans (SIPs) which brings automatic discipline, time diversification and rupee cost averaging.


3. Growth vs. Dividend Option
Third, you need to choose between dividend and growth option of ELSS funds. By choosing dividend option you’ll get back part of the capital / returns every year (but at the discretion of the fund house) despite a three year lock-in period of ELSS funds. However, in my view, growth option is always better than dividend option.

Mutual fund houses have found a way to circumvent 3-year lock-in-period of ELSS schemes by declaring huge dividends usually during the last quarter (Jan to March) of the financial year to lure investors. It increases the effective tax deduction available in the first year itself.

For instance, let’s say you invest Rs 50,000 in a ELSS and soon thereafter the fund house declares a dividend and you can back Rs 10,000 just after a few days (or a few months); the tax deduction @ 33.99% (assuming you fall in the the highest tax bracket) is 16995, but due to cash back, your net investment is only Rs 40,000 and hence the effective tax deduction becomes 42.49%.

However, it shouldn’t be the criteria while choosing a particular ELSS fund over the other. So please don’t get swayed by the high dividend rates of ELSS schemes. To know, why the dividends don’t make any difference, please click here.

HAPPY INVESTING!

Also Read

1. Investing in PPF - 10 Practical Tips

2. How to Invest in NCDs?

3. Gold ETFs - The Best Way to Invest in Gold

4. ELSS - The Best Section 80C Tax Saving Option