30 January, 2012

Financial Planning for NRIs

NRIs are a very big community of Global Indians ( about 20 million at last count ) who have an umbilical connection with their motherland and have been regularly investing  in India.  While the emotional tugs are there, there are also real reasons why NRIs want to invest in India.

The returns on investment abroad are low, which makes sending money to India even more attractive, what with India having attained a degree of popularity as one of the engines of growth for the world and consequently the attractive returns that it is able to offer.

From the NRI perspective, the returns from virtually every investment done in India, would be significantly better as compared to the returns possible in jurisdictions like US, UK or other developed economies. 
That being the case, NRIs  are predictably excited to invest here.

Planning for them
Broadly speaking, there is not too much difference between a financial plan for NRIs and resident indians. Both have goals which need to be achieved from the cashflows that they have.  So, a financial plan would broadly be the same. However, there would be differences which are worth noting.

Currency Fluctuation :  Since, they would be earning in one currency and investing in Indian Rupees, the currency fluctuation can play a major role in determining whether an investment would turn out to be  good for them or not. For instance, if the investments are made in India and they do not want to repatriate the proceeds, the currency fluctuation risk is not there. However, if they are investing here and may want to repatriate at some point, a weakening rupee would eat into their returns. Hence, though an investment may offer attractive returns in rupee terms, it may not remain attractive when it is repatriated. This is a real and present danger. Hedging for this could be an option. But, this is has not been easy even for corporates, who were caught on the wrong foot recently, when Rupee weakened to below fifty two against the dollar. Corporates had hedged, assuming the rupee will at best weaken to Rs.48-49 to a dollar.  

Estimation of income/ expenses :   Many NRIs have intentions of coming back to India at some point. Many in my association, have expressed intentions of coming back to India after their working lives.  This would mean that all Income, expenses & inflation for those expenses, till their stay abroad, will conform with the prevalent norms in the host country.  Also, the benefits which they will get in the host country will also have to be taken into account. The benefits after retirement, which includes medical benefits could be a lure for many to stay back. Also, though they have every intention to come back, they develop cold feet, nearer the event and simply stay put. So, while planning, one has to make a provision to take care of this situation - if at all they do not come back to India and continue to reside there, they  should still have the resources to live in comfort,  in the host country.

Travel  :  NRIs do visit India from time to time, with their families. This is a unique expense that has to be provided for in their case, based on their frequency of travel. This can be a big expense, considering that the entire family will be flying down to India and will travel within India. Also, it is almost an accepted  custom that NRIs would book and send tickets for their parents and other close relatives, when they have to visit them in the host country. These expenses would need to be factored in, in a plan for NRIs.

Nuances  :  There are local customs, expectations which need to be complied with. An example of this would be that, in some communities, charity is an article of faith and hence a client living abroad may have to contribute according to expectations there. These can be estimated only with the help of the client, as a planner would never come to know of such expenses.  

Investment aspects to be considered for NRIs

Taxation is an aspect to be considered in case of NRIs, before deciding whether the investment option is a good one or not.  For instance, the taxation for Equity Mutual fund investment for NRI is nil, just like in the case of resident Indians, if the investment is kept for more than 12 months. Even Dividend Distribution Tax is nil. This makes this investment class, quite worthwhile from their point of view, if invested for over a year. 
Short-term capital gains are at 15.45% for both NRIs and Resident Indians.  However, in case of NRIs, there is a TDS deduction of 15.45%, in this situation. 

However, in case of debt mutual funds, in case of short-term capital gains, the taxation applicable is at one’s income tax slab. However, TDS will be deducted at 30.9%, which can be claimed back by a person who is filing tax returns in India.  This is a long and tortuous process of waiting out for the refunds.  

Long-term capital gains ( LTCG ) tax for debt mutual fund schemes for both resident and non-resident Indians, is the lower of 10% without indexation and 20% with indexation. However, in case of NRIs, there is a TDS of 20.6% ( the rate after indexation ). Since it is after indexation, the actual incidence of tax will be lower than 10%. However, claiming back this amount is an issue for those who file returns and is completely lost to those who do not file returns.

A better option for NRIs investing in debt funds for 12 months or less, would be to invest in the dividend option and in the growth option, if it is for over 12 months. 

FMPs have been giving good returns, in the recent past. One can approximately expect to receive about 8.5% returns after tax, based on the instruments in which FMPs of just over a year invest. This would be after the TDS, which would be deducted.  Debt Mutual Funds of medium to long maturities also are attractive for NRIs, especially at this point, when interest rate cycle is poised for a direction change. Over the next one to two years, double digit returns can be expected. The same beneficial tax treatment would work here, making these funds attractive bets for NRIs.  

The other investment option of choice for NRIs is property.  NRI / PIO  may acquire immovable property in India other than agricultural land/ plantation property or a farm house out of repatriable and / or non-repatriable funds. On sale, repatriation of the sale proceeds is possible, either from NRE or FCNR account. This would be possible only if the property was acquired out of foreign exchange sources in the first place.

It is apparent that planning for NRIs is not very different, as compared to resident Indians. There are a few differences, which a planner needs to be aware of while planning for an NRI. A knowledge of the financial, tax and legal landscape of the host country would be helpful in drawing up a meaningful plan for NRIs.

Article by Suresh Sadagopan published in Jan 2012 issue of Financial Planning Journal

Is it better to pay tax than save tax?

Saving tax is a religion policy in India, so much so that people do the equivalent of walking barefoot in the desert,   to collect a few dates. People want to ensure that they pay as less taxes as possible.
While saving taxes is a legitimate aspiration, overdoing it actually does more damage than help. This is something that eludes the understanding of most people.

There are several instances where meaningless investments for the sake of saving taxes, takes place. Take the case of medical insurance… there are many who are covered adequately with a group medical insurance, by their company itself. But they still want to invest in another policy, just to save taxes under Sec 80D, where the eligible amount for self and family is Rs.15,000/-pa and that for their parents are another Rs.15,000/-pa ( Rs.20,000/-pa, if the parents are senior citizens ).  Some of them are so bent upon taking these, even though they clearly don’t require it. They offer all manner of justifications as to why an additional medical cover would actually be good for them. They go into aspects like soaring medical costs and chances of all falling ill and finding the cover inadequate in a family floater. They also very helpfully paint the scary picture of what happened to their neighbour/ friend / colleague, when they were caught short in a medical emergency. 

Having more medical cover than necessary is a waste of money. It is a sheer waste to invest Rs.15,000/- pa to save taxes of Rs.4,635/- ( even at the highest tax slab). Does not look that intelligent to do this, does it?
Then there are those who would invest in insurance policies to save taxes. Now, insurance is for security. But, from time immemorial, insurance has been sold on the plank of tax savings and investments, so much so that people now look at insurance policies only for these. The security that an insurance policy affords, is simply a forgotten footnote. When the tax season looms and the employer has delivered an ultimatum to show proof of tax saving investments, the scramble begins. It is then they come across helpful insurance agents who would invest their money and give proof of investment, the same day or the next. That ofcourse, is the magic word. 

They invest in an insurance policy, get the proof, submit it to their office – and life is bliss!

The main thing here is that most don’t know what policy they have invested in, whether that policy is suitable to them, whether the tenure invested is appropriate, what returns it could offer and whether it is a traditional or an unit linked product etc. In a nutshell, they have not evaluated the product for it’s merits and have just invested to save tax. This kind of investment is very common in our country and is doubly harmful. Firstly, they invest a big sum of money in a product that they may not need. Second, they would be bogged down with it for a longtime. Else, if they want to get rid of it, they would suffer a gut-wrenching loss. It would have been far better paying the taxes themselves, instead of shooting oneself in the foot.

Another favourite among people is to buy a home to save tax. If it is the first home, the deduction available is just Rs.1.5 Lakhs pa and tax savings would amount toRs.46,350/-, in a year. For this reason, if one were to buy a home, it can put enormous pressure on one’s finances. Due to this, one’s lifestyle becomes crimped and it stays that way, for extended periods, just to save some tax and own an asset over time.  It might have been much better just to have paid the taxes, invested the money after that, live life decently due to better cashflows ( in the absence of constricting loans ) and end up buying a property later,  when it is actually required. 

Now, comes the most interesting part. Borrowing to save tax! Come December and the scramble to submit proof sets in. Those short of cash, resort to borrowings to save tax.  People are known to take personal loans or credit card loans to invest in tax saving instruments. If one were to calculate the costs and efforts vis-Ă -vis how much money is being saved, it may not make much sense to do it in the first place. 

Obsession to save tax at all costs is toxic. Any investment made, even if it made for tax savings, should make sense in the overall scheme of things. It needs to be a good investment. Tax savings should be an incidental benefit. We need to realize that if we actually calculate the total costs, it may be much costlier saving taxes than paying taxes, in many cases. Save taxes, where you can. Simply pay it, if it does not make sense to save those taxes. You would be better-off that way.

Article by Suresh Sadagopan published in Business Standard on 29/01/2012

Wrong choices for tax savings

Our investors keep tax saving investments for the last minute – this is the rule rather than the exception. When one does this, there is not much time to evaluate the options and take an informed decision. Also, most have an aversion to finance. Hence, they just rely on whoever is approaching them and just get information from them, before taking the decision. Needless to say, such decision making can go wrong. Hence, they tend to make wrong choices.

1.     1.   Investing in Life Insurance for savings tax is very common.  As common is investing in policies about which they just don’t know anything about – what kind of policy, what are the features and benefits, whether it is suitable to them etc. Such investments are money down the tube.

2.       2. Putting money into medical insurance policies so that it may save tax, when one is adequately covered by a policy from the employer. The compulsive tax saving instinct which is fairly common makes one to put money in medical policies, which is in effect throwing good money.

3.      3.  Investing in low-yielding instruments like NSCs to save tax is hardly a good idea as the inherent post-tax returns are very low. Even though one saves tax, it still does mot make sense.

4.       4. Investing in a home primarily to save tax is a bad option too. Lots of people go in for a home only to save tax. Tax saving for the first residential home is limited to a deduction of Rs.1.5 Lakhs, which translates into a saving of Rs.46,350/- ( for a person in the highest tax slab ). The pressure it puts due to the liability and the EMI for extended periods is phenomenal. It also puts pressure on one’s normal lifestyle itself, if this investment has been stretched.

5.      5.  PPF is a good investment in itself. But, for those who just look at the returns and put in money without looking at upcoming goals, it becomes a bad choice. PPF is a longterm investment instrument and has to be used only when the tenure matches one’s needs. Else, one will be caught with money in the account, but nothing to meet upcoming needs.

Pulling money away from Equities now is a bad idea

The ruling sentiment now in the environment is of gloom. The stock markets have been on skids for over a year and people are wondering, if it will ever  go back to the levels seen in 2007 end. The negative returns are hurting and hurting bigtime. Sensex has given a negative 24% last year. So, lots of people are wondering why they invested in Equities and why they should care to keep the investments in equities, if even the capital is eroding.

Investors reckon that it makes better sense to invest in simple bank FDs itself, which atleast gives a positive return. There are flaws in this argument, though not apparent at first.

Firstly, volatility does not mean poor returns. As long as the amount stays invested, the profit or loss is virtual. It is when we cash out that the profit/loss becomes real.  So when the markets are in a tail-spin and subject to the fact that the investments are in the right places, it makes sense to stay put. There is no gain carping about the poor returns. It is well known that the stock markets goes through these whip-saw movements and deliver returns, over time. This volatility at this time is not new. Volatility is in the very nature of equity markets. When an investor has invested in equity markets, it is with that knowledge that they have invested.  One thing that should  be a source of comfort for investors is the fact that equity markets have given the best returns of any asset class, long-term.  Since 1980, Sensex has given a return of about 17% CAGR, to date. That is not too bad, is it?

The current favourite gold has given single digit returns in this period.  Gold reached an all-time high of about  USD850 an ounce in 1980 and had been sliding for most of the period after that, reaching about about USD271 in 2001. After that, it has been on a steady rise, till a few months back. There was a fall of over 20%, in dollar terms in the recent months, though the fall in rupee terms has been less drastic, thanks to a depreciating rupee.  Lots of people are betting on gold just looking at the past 10 years performance alone.  Property too has it’s own cycles. The bust which started in 1995 was in place till 2003. After that there had been a meteoric rise. But, so had the equity markets. But, equity markets rise and fall rapidly. And that, to come back to the point, unnerves people.  Sensex has risen from 100 to about 16,000+ now, which is not bad at all.

Investors should understand that equity will work in the longterm. You don’t have to keep seeing stock quotes everyday, just because it is published. Seeing the poor returns now and moving to debt would be shooting oneself in the leg, which unfortunately lots of people do. But, that smacks of lack of basic understanding of the equity markets. One would book losses, if one were to exit now and invest in another instrument, which could barely beat inflation. Poor choice. If one has patience, the same investment would eventually come up. Now, people wonder if it will ever come up. That’s laughable again. Equities are business ownership units. Businesses will be there and will make money – their revenues are always inflation adjusted ( they can increase prices ). So if you are participating in food businesses, you will make money. It is only the utter pessimist who would say everything will shut down and hence stock markets can’t go up at all. If that is the case what on earth can one do with gold and property?

Now, will the markets go down this year? Good question. But there is no conclusive answer. It can ofcourse, if the global situation worsens. It can fall by 20%, even a third perhaps. But that is in the realm of conjecture. The right question to ask is, will the markets come up and give good returns in future? The answer is a resounding yes. Hence, it makes sense to just stay put. If the markets go down further, you will not suffer losses as long as you stay invested.  There will be those who will exit at the bottom. Let it not be you. And those same people will buy back when a bull rally reaches it’s peak – losing both ways.  We have a hard time telling investors to just stay put. Some of them want to rejig the portfolios all the time – in the hope that it will miraculously recover. It just worsens the situation, as we have seen.

Just stay invested. Better still buy at all dips. You would have done yourself a big favour, doing that. You will realize that years from now!

Article by Suresh Sadagopan ;  Published in Business Standard on 22/01/2012