PPF Limit Increase : Duh!

I had written a series of articles in November 2011 about the change in the PPF rate of interest and its general economic implications.  I got some pretty interesting comments based on that series like the one here.  (Are PPFs really that risky) I seem to have gotten so carried away by that series, that I completely missed the fact that the PPF Limit was also increased at the same time.  Effective December 1st, 2011, the limit per year for PPF investment has been increased from Rs70,000 to Rs1,00,000 per annum.  (Yes, that's 1Lakh Rupees per year) This means for the current financial year, if you had already maxed out your PPF contribution of the year for Rs70,000, you can now go in and add an additional Rs30,000 before March31, 2012.  Starting next financial year, you can invest upto Rs1,00,000 into the PPF account.  This sounds like a good deal to me.  Now as long as the finance minister could also increase the 80C limit, we would all be in good shape!!

Personal Finance News : MCX IPO

The MCX IPO opened yesterday February 22nd, 2012.  MCX is the commodities exchange in India, and will be the first publicly traded exchange.  I have seen good reviews about this IPO at all major financial sites, and most reputed financial advisors seem to be recommending this IPO.  I figured I should apply for it as well, and did so yesterday morning.  Interestingly I seemed to have forgotten that retail investors can now invest upto Rs 2Lakh in an IPO.  Earlier the limit used to be Rs 1Lakh.  Was checking out the Business Standard early this morning, and it claims that the MCX IPO was subscribed 91% on the first day with 1.5X in the retail category (clearly I will not get full allocation), 0.16X in HNI (this is very surprising;  does the HNI community know something that I don't?) and QIB portion 0.74X (again not hitting the limit)  In any case, the deed is now done, and we shall see how the allocation works out!

Why You Shouldn’t ‘Invest’ in Life Insurance

Insurance products are incredibly complex, despite their heavy regulation. Financial products are typically of two types —high-risk, where the returns cannot be predicted in any reasonable manner, and low-risk, where the return is either guaranteed or specified (the risk is in whether the seller will go bust). Equity is a high-risk proposition, while fixed deposit and other debt options are the second. Insurance products provide a mix-and-match,

Most people give up before they reach the "real return" calculation — which is why insurers can easily stuff charges into such policies, knowing that if someone is silly enough to invest with a 5% real return, he won't even know that they can take a significant chunk of money as commissions.

Early Retirement in India : Extreme Style

Previously I had published a blog entry about one of my role models Jacob Lund Fisker.  Jacob is the driving force behind Early Retirement Extreme, a philosophy of living in general that espouses the concepts of simple living, aggressive savings, and an overarching desire to become financially independent as quickly as possible.  Jacob's also published a book about his early retirement experience that is a must read, if you can get your hands on it.  Now a lot of the examples that Jacob cites in his book are relevant only in the US, and would sound very out-of-place in India.  So I always looked upon his thoughts as more of a vision and guidance, than as specific steps to follow to reach my own financial independence and subsequent early retirement.  For example, Jacob suggests that instead of using a dryer to dry your laundry, you could "air-dry" your clothes after washing, to save on electricity.  Well guess what! none of us in India can benefit from this wisdom, since we all hang our clothes out to dry in the sun anyways.  There are several other examples like this one, which led me to believe that there isn't really much that we can takeaway here in India from Jacob's lifestyle and early retirement experiment.  However, recently I had some time to review several of his blog posts on Early Retirement Extreme, and here is something thought-provoking that I came up with.

There is a particular post on his website that is very relevant to us here in India.  But before I get into the specifics of the post, here is a little quiz question for you.  Which is the more expensive country to live in?  India or the United States?  Which country has the higher standard of living? India or USA?  Which country has the stronger currency, and where do you expect cost of services and general cost of living to be higher?  India or the US? 

If you answered the US for all of the above, you are no different from me, and a million other folks.  You naturally assume that since the US is the more developed country, and since the standard of living is higher there, the general cost of living (in Rupees to make it a fair comparison) should be much higher in the US.  So basically the salary or income that you get here in India, will never be sufficient to live in the US, right? 

WRONG!!  Here is a very very interesting post from Jacob that walks us through, in great detail, how he manages to live in one of the more expensive places in the US (the San Francisco Bay Area) for only $7000 per year.  That's right, you read it correctly, $7000 PER YEAR ONLY.  Convert that into Rupees assuming $1 = Rs50, and you get Rs3.5L PER YEAR expenses to live in the USA.  Now the San Francisco Bay Area is pretty expensive to live in, and it would qualify the same as living in one of the major metros in India.  In fact, if anything, the cost of living there should be much higher than it is here in any major metro or Tier 1 city.  However, Jacob for over 10 years, was able to live for only $7000 per year, or Rs3.5L per year, which in turn is less than Rs30000 per month. 

Now of course, even Rs30000 is a lot of money for the average Indian to earn per month in India.  However the point here is that it IS possible to significantly reduce your expenses to extremely low levels.  If it can be done in a high consumption economy like the US, then surely it can be done, in a much more aggresive fashion here in India.  This thought is the basis of my goal to save about 85% of my take home salary.  I have stated this goal before, and after re-reading Jacob's post, I am now even more committed to it.  Are you with me?

I made a mistake : Fixed returns can lead to Early Retirement

Several months ago, I had stated to my wife, quite brashly if I may add, that debt-like returns would not find any place in our retirement portfolio.  I have been in a tearing hurry to grow our retirement corpus and I thought that the slower growth rate of debt-like investments, when compared to equity based investments, was something I could not tolerate.  In fact I was so convinced about my logic, that I even posted a blog entry justifying my position.  I could not have been more WRONG!!  However, like all good things, ones financial strategy is also never 100% right, and there is always room for improvement.  I have now realized my mistake, and made room for some more fixed income into our retirement portfolio.  There is one key recent investment opportunity though that triggered my change of heart.  If you are a keen follower of personal finance, then you already know what I am talking about!  Yes, I am of course talking about ...

... tax free infrastructure bonds.  But before I get into the details, here are some related thoughts.  The biggest fear I have with building a retirement portfolio is taxes.  Taxes can take a huge bite out of my withdrawals from the retirement portfolio when I eventually need the money!  I cannot afford to pay anywhere from 10% to 30% of my withdrawals to the government.  Unfortunately there are only a few ways in which you can protect your retirement portfolio from taxation.  Your EPF and PPF contributions follow the EEE concept.  This means that the money going into PPF/EPF is not taxed, it grows tax free, and is not taxed when you withdraw the money.  However, there is a maximum limit to how much money you can save this way.  PPF maxes out at Rs1Lakh per year (was Rs70,000 earlier; increased to Rs1Lakh since Dec'2011)  EPF is limited to 10% of your basic salary if you are a salaried employee.  My next target is typically the long term capital gains route.  Currently long term equity capital gains are taxed at 0%  So you can stash all of your retirement portfolio into equity based investments, and withdraw them via SWPs (Systematic Withdrawal Plans) without worrying about taxes (assuming naturally that you have held these investments for more than a year)  However, the first problem with this approach is that equity based investments tend to be high risk, and you do not want to be withdrawing from your equity portfolio in a market downturn.  Also with the new proposed DTC (Direct Tax Code) around the corner, this benefit might be withdrawn at any time.

Dividend income is the other possibility.  You can currently invest a large part of your retirement income in dividend yielding equities (either through directly buying high dividend yielding stocks, or through dividend mutual funds) and live off the yearly dividends that they generate.  However, though dividend returns are currently not taxed, that could also change once the DTC is approved.

I am not aware of any other means currently to protect your retirement withdrawals from the taxman.  In this scenario, the announcement of the tax free bonds came as a welcome relief, and really perked my interest.  Back in 2003, the government of India had announced RBI relief bonds at 6.5% tax free interest.  Unfortunately at that time I was not focused on my retirement planning.  As I learned more about the taxation policies, I began to realize that there were very few avenues to save money, and build a portfolio that could generate sustainable and predictable yearly returns, without paying a fat share to the government.  The US allows for investments via ROTH IRAs.  This structure, allows you to channel your investments (upto a limit of course) through it such that your withdrawals are tax free.  The ROTH IRA is basically a TEE structure.  The money going in is already taxed, but once inside the structure, it can grow tax free, and can be withdrawn tax free.  This is a powerful method to rapidly grow your investments.  In India the only TEE structures are life insurance policies, ULIPs, and pension plans.  Pension plans and traditional endowment policies are typically linked to fixed return instruments, and hence their returns tend to be low.  ULIPs are no different from long term MF investments from a taxation perspective.  India currently does not provide a formal TEE structure like the ROTH IRA. 

Therefore when the tax free bonds were recently announced, I was pleasantly taken by surprise.  I mentioned to my wife the moment I noticed this investment avenue that we should take full advantage of it.  I had completely forgotten my earlier statement that I would never include debt-like instruments in my retirement portfolio!!  The opportunity to lock in tax free returns of over 8% for 15 year periods was too good to pass up.  I will not get into the details of the tax free bond offerings from NHAI, PFC, HUDCO and IRFC here.  You can easily find tons of literature describing the various aspects of these bond offerings on the internet.  Suffice it to say that guaranteed pre-tax returns of upto 12% per annum (for folks in the highest 30% income bracket) were too mouth watering to pass up.  Obviously several people thought the way I did.  The HNI allocations of all these bond offerings were over-subscribed within days.  Fortunately all of them had separate allocations for retail investors like you and me.  There was a limit of Rs5L per bond offering in the retail category, which I thought was high enough for most retail investors.  In case you had more money available to invest, you could have spread 20L across the 4 offerings, and a total of 40L if you and your wife applied separately.  At 8.6% tax free returns, you can generate ~Rs29K per month tax free for the next 15 years guaranteed!!  This is possibly the highest guaranteed returns post-tax that you can generate across any existing TEE schemes. 

No wonder I had to admit my mistake, and change my retirement investment philosophy.  My only regret at this time is that I could not free up enough capital to invest in this tax free offering.  If there are more tranches of such offerings in the future, I fully intend to watch out for them, and plan upfront to free up some more cash to invest in such risk free and tax free opportunities.  Did you capitalize on this opportunity for your retirement portfolio?  Such no-brainer opportunities do not come very often!  It would be interesting to know how many of you participated in this bond offering.  Let me know.

Want to eliminate the stress of filing taxes?

Now that I'm in my second year of VITA (Volunteer Income Tax Assistance a program of the IRS) I feel like I've observed and learned enough to decipher what a person can do to make the tax return process a whole lot easier.

BE ORGANIZED
The best thing you can do to make filing your taxes a more painless experience is to come organized. This is especially important if you are a small business owner or filing itemized deductions. If you have a small business, keep track of your receipts, track your mileage, and add up your income before you get to the site. The same goes for people filing a schedule A - itemized deduction. It’s ok if you don’t know exactly what you can deduct and what you cannot, but if you’re planning on using it, keep all the receipts and organize them. A tax preparer’s worst nightmare is a client walking in with a shoebox of papers and receipts, expecting the preparer to go through each and every item  with the client.

If you want to be completely prepared (which will be beneficial to you, because the return will have a higher chance of being correct – there’s actually a study on that), I will write a second post on how to determine whether or not to file itemized deductions and a third post on tips for small business owners.

BRING LAST YEAR’S RETURN
If you want to hurry the process along, bringing your previous year’s taxes is the best way. Even if you’ve had many changes in the past year, having last year’s return will give the preparer an idea of what will need changing. It can trigger more questions to make sure you’re filling correctly and can answer questions about this year’s taxes (such as: was your EITC disallowed last year? did you itemize last year? did you claim dependents last year?) These questions may sound simple or obvious to you now, but often time people start second guessing themselves or maybe someone else answered them the year before. Oh and another reason you should bring last year’s return: sometimes the way you write your name or the way it is written on the Social Security card does not coincide with your taxes. Thus, brining last year’s taxes could prevent a reject and get you your refund faster!

GET A BABYSITTER FOR THE KIDS
Seriously, get one…or at least bring something VERY entertaining for your kids (age 0-6). Having children at the tax site brings a high level of stress to EVERYONE.  I realize sometimes it’s unavoidable, but if there were any way you can leave them at home, everyone would appreciate it. When neither the client nor the tax preparer can hear each other over a screaming child, or they are distracted because the child is making photocopies of their hand, it will take a lot longer and become tiring very quickly.

LAST THING
If you make around $50,000 or less, go to a VITA site! It's completely free and a volunteer, trained by the IRS, will be taking you through the return. If you live in the Bay Area, check out earnitkeepitsaveit.org for a site near you.  No one will be charging you extra fees for a refund or an extra form that needs to be filled out. All sites file electronically so you will be able to get your refund fast, and most sites are nonprofit i.e. really friendly people who are most likely going to offer you other free services while you’re there!