Fixed Income products like Fixed Deposit’s and Postal Savings Schemes (Senior Citizen Bonds, Postal MIS etc) are the bedrock of many Retirees as they give stability and regular income. However, they suffer from lower returns (just around inflation) and taxation issues.
So what exactly should the investment mix of a RETIREE be? While there is no clear cut answer, as it should be investor specific, I have listed some guidelines which should be kept in mind for the above set of investors. I have omitted some complexities and hence made it simple.
1. Fixed Income instruments will give regular income but fail miserably in beating inflation. Hence, it would be very important to have inflation beating instruments in some proportions in one’s portfolio. Also, many of the fixed income instruments have the implication of taxation which reduces the post tax income.
2. The allocation (of inflation beating products) should be minimum 25% for retired investors. This could be increased based on the cash flow situation and the size of the portfolio. Equity Mutual funds, while being volatile in the shorter time frame, would be a good choice for these products. This would also reduce the taxable income. Build this part of portfolio gradually through a staggered approach so as reduce the market timing risk.
3. The allocation of fixed income products for a Retired person should be done such that one has enough regular income but the income is such that it falls below the taxable income. Assuming 8% p.a. annual interest, one can invest maximum Rs. 62.5 lakhs in taxable fixed income options like FD’s, Postal Schemes etc (non taxable income is Rs. 5.00 lakhs i.e. Rs. 3 lakhs basic exemption plus Rs 1.50 lakhs after investing under Sec 80C plus Rs 50,000 interest exempt). If one has other or rental income (fully taxable) of say Rs. 2 lakhs per year, then the maximum investments in FD like instruments would be Rs. 37.75 lakhs (approx). Also, note Rs. 40,000 p.a. pension income is also tax exempt.
4. The remaining allocation to fixed income options should be done through Debt Mutual Funds. There is common myth that debt mutual funds are very risky as they invest in shares. Kindly note that debt mutual funds invest (or loan) the money to government, banks, PSU’s or good corporate for a fixed period at a rate of interest. This is returned back to the investors after the expenses, subject to the associated risks which are considerably lower than equity instruments.
5. Debt Mutual Funds also have a better taxation structure than your other fixed income instruments. Firstly, they are not taxed till withdrawn. That means you can postpone taxation till the money is required. Secondly, exits after 3 years are taxed at 20% net of inflation unlike FD’s which are taxed fully.
6. Avoid taking dividend income from equity/debt and hybrid mutual funds as they are not tax efficient. Instead, one can opt for regular monthly withdrawal which is very tax efficient as exits are taxed at a lower rate than dividends. There would not be any TDS too.
7. One could avoid investing in real estate as the rental yields of apartments are quite low (not more than 3% p.a.) and fully taxed. These could be exited and re-invested in financial instruments as mentioned above.
8. NRI’s who are planning retirement in India should also bear in mind the above points so that, lower returns with large taxation do not hit them.
While the environment looks challenging for retired investors, a prudent approach would help in securing one’s regular income. It would be prudent to discuss your personal situation with a fee based Financial Planner and not have a piecemeal approach.
1. The above are personal opinion and should not be construed as financial/taxation advice.
2. As each individual circumstance is different, please contact your tax consultant/advisor for more clarity.
3. The cases and assumptions above are only for illustration and made for understanding purpose only.
4. Mutual Fund investments are subject to market risks. Kindly be aware of the risk factors before investing.
Feel free to get in touch with me at firstname.lastname@example.org / 98455 57582 for further clarifications.
Happy Retirement Planning!!
Naveen Julian Rego CFP
SEBI Registered Investment Adviser
Reg. No. INA200004250
28th June, 2018