Tuesday, August 28, 2012

National Pension Scheme and Taxation at Maturity

One of our blog readers had posted a query in the article titled "Is National Pension Scheme (NPS) A Worthwhile Investment Option?" about the Taxation aspects of the NPS Scheme. So, here we are. The purpose of this article is to outline the Taxation aspects of the National Pension Scheme when you Retire...

Before we begin - We all know that the investment you make against NPS is exempt from Income Tax as per the existing tax slabs. So, I dont think there is a need to cover that here.

Tax treatment of NPS when you reach the retirement age:

The contributions made by you and your employer get accumulated in your Tier I account and the value of such corpus depends on factors like quantum of money deposited every year, the asset classes (The fund type) opted by you for investment and the returns generated by your pension fund manager. Once you complete the 60 years of age, you have to compulsorily purchase an annuity for an amount equal to minimum of 40% of the accumulated balance in your NPS account.

The annuity needs to be bought from a life insurance company which is registered with IRDA (Insurance Regulation and Development Authority). In case you wish to withdraw the money before you complete 60 years of age, you can do so but in that case you will have to purchase an annuity utilizing minimum of 80% of the accumulated corpus at the time of withdrawal.

If you are already 60, you can withdraw the entire amount but as mentioned before, you need to purchase an Annuity for at least 40% of the corpus. This amount you use to purchase an Annuity is not taxed right away but, the pension you receive will be taxed. The remaining money (that is left after purchasing the Annuity) is taxable.

Please note that it is not mandatory for you to withdraw the whole corpus left after purchase of mandatory annuity. You can opt to withdraw the balance amount in a phased manner. However you need to withdraw a minimum of 10% of your accumulated corpus every year. This account has to be closed once you reach the age of 70 years. This money received by you, either lump sum or in a phased manner is fully exempt as per the provisions proposed in DTC.

In case of untimely death of the NPS account holder before completion of 60 years of age, the nominee can withdraw the corpus accumulated at the time of death of the account holder. The money received by the nominee or legal heirs is fully exempt from Taxes.

The annuity which you receive is taxable on yearly basis. This annuity you receive will be considered your income and hence is taxable as per the Indian tax laws. But, as per the current tax slabs, any income of up to 2.5 Lakhs is fully tax free. For more details on the current Tax Slabs - Click Here

As a continuation to the article titled "Is National Pension Scheme (NPS) A Worthwhile Investment Option?" I want to reiterate the fact that NPS offers you an excellent tool to save your tax and plan for your future as well. It is very tax efficient because you get the tax benefits for the whole amount of your contribution and need to use only 40% of the accumulated wealth for purchase of annuity. It is pertinent to note that though the annuity is taxable in your hand at the time or receipt, the applicable rate of tax would in all probability be very low as compared to the rate of tax which you are paying now.

So, go ahead, plan for your retirement and retire RICH!!!

Monday, August 27, 2012

The European Union - An Overview

One of our blog readers "Anish" wanted to know more about the Eurozone Crisis. So, as a starting point to that complicated topic, let us first take a look at what this Eurozone or the European Union is. Once we get a fair idea about what the Eurozone is, it would be easier to understand about the crisis.

So, what is this European Union?

The European Union (EU) is a unification of 27 member states united to create a political and economic community throughout Europe.

The 27 member nations are:
1. Austria
2. Belgium
3. Bulgaria
4. Cyprus
5. Czech Republic
6. Denmark
7. Estonia
8. Finland
9. France
10. Germany
11. Greece
12. Hungary
13. Ireland
14. Italy
15. Latvia
16. Lithuania
17. Luxembourg
18. Malta
19. Netherlands
20. Poland
21. Portugal
22. Romania
23. Slovakia
24. Slovenia
25. Spain
26. Sweden
27. United Kingdom

Note: Croatia is scheduled to become the 28th member of the EU on July 1st 2013. So, as of now there are only 27 member nations.

Did the concept of EU just start recently?

Actually speaking, No. Though there was no formal European Union as such, the leaders of the European nations have always been working towards cooperation among the nations in Europe. In fact, the first ever known cooperative effort was in 1950 when the European Coal & Steel Community was created to facilitate easier trade between nations. 6 nations were involved in this initial treaty and they are often referred to as the founding members of this whole concept of EU. The nations were Belgium, France, Germany, Italy, Luxembourg and Netherlands.

During the cold war period, there was widespread tension and division between the Eastern & Western parts of Europe. To alleviate this, the Treaty of Rome was signed in March of 1957, thereby creating the European Economic Community. The creation of this community allowed people and products to move freely throughout Europe. As time went by, more and more nations joined this community.

Lastly, the demolition of the Berlin Wall in 1989 created a Single Market for Trade in Europe.

The Modern-Day EU

The modern day European Union or Eurozone effectively began due to the Treaty of Maastricht which was signed on February 7th 1992. It was put into action on 1st November 1993.

The Treaty of Maastricht identified five goals designed to unify Europe in more ways than just economically. The goals were:
1. To strengthen the democratic governing of participating nations.
2. To improve the efficiency of the nations.
3. To establish an economic and financial unification.
4. To develop the "Community social dimension."
5. To establish a security policy for involved nations.
In order to reach these goals, the Treaty of Maastricht has various policies dealing with issues such as industry, education, and youth. In addition, the Treaty put a single European currency, the euro, in the works to establish fiscal unification in 1999. In 2004 and 2007, the EU expanded, bringing the total number of member states to 27.

How the European Union (EU) Works

One of the biggest complaints that citizens of India have is the fact that, the national ruling alliance is a coalition government and hence managing the expectations of all the member parties in the alliance is a challenge that the alliance leader has to live with day in and day out…

If collecting a bunch of state level parties that all belong to a single nation has its troubles, imagine how coordinating or governing a group that involves different countries would be??

With so many different nations participating, the governance of the EU is challenging to say the least. However, it is a structure that continually changes to become the most effective for the conditions of the time. Today, treaties and laws are created by the "institutional triangle" that is composed of the Council representing national governments, the European Parliament representing the people, and the European Commission that is responsible for holding up Europe's main interests.

The Council is formally called the Council of the European Union and is the main decision making body present. There is also a Council President here and each member state takes a six month turn in the position. In addition, the Council has the legislative power and decisions are made with a majority vote, a qualified majority, or a unanimous vote from member state representatives.

The European Parliament is an elected body representing the citizens of the EU and participates in the legislative process as well. These representative members are directly elected every five years.

Finally, the European Commission manages the EU with members that are appointed by the Council for five year terms- usually one Commissioner from each member state. Its main job is to uphold the common interest of the EU.

In addition to these three main divisions, the EU also has courts, committees, and banks which participate on certain issues and aid in successful management.

The Mission of the European Union

The European Union's mission today is to continue prosperity, freedom, communication and ease of travel and commerce for its citizens. The EU is able to maintain this mission through the various treaties making it function, cooperation from member states, and its unique governmental structure.

Now that we know what the European Union or the Eurozone is, we are well equipped to go into the topic of Eurozone Crisis.

Saturday, August 25, 2012

How have LIC’s ULIP Plans Performed So Far?

Life Insurance Corporation of India, the government owned and the largest Insurance Company in India has flouted numerous and I really mean numerous ULIP Plans over the past 5-8 years. Every time they feel that a ULIP Plan isn’t performing well or if they feel people weren’t buying their plans, they went ahead and created/started a new plan and started selling it. The agents too sold them religiously by distributing pamphlets that claimed extravagant and frankly impossible returns. Anyways, the indian investor population, driven their greed to make quick bucks just bought into every one of those schemes. The past decade has been a real bumpy ride for the Indian Stock Market. Even the best fund managers have been unable to read the markets properly. So, how have the fund managers at LIC Fared? How have the various ULIP Plans flouted by LIC Fared? Well, this is what this article is all about.

So, what are those numerous ULIP Plans flouted by LIC?

They are:
1. Profit Plus
2. Fortune Plus
3. Future Plus
4. Market Plus
5. Money Plus
6. Market Plus 1
7. Money Plus 1
8. Child Fortune Plus
9. Jeevan Saathi Plus
10. Endowment Plus
11. Wealth Plus

Note that I haven’t included ULIPs that were started before 2006 as well as ULIPs that were Health Insurance Plans in disguise. If we include them as well, the number could be even more.

NAV Details of the above Mentioned ULIP Plans:

Fund NameInception DateGrowth FundBalanced FundBond Fund
Profit Plus3929510.9914.7415.07
Fortune Plus3929511.512.2514.47
Future Plus3841223.9718.1815.79
Market Plus3889914.5915.6316.52
Money Plus3905211.6114.1415.41
Market Plus 13960013.5112.2113.81
Money Plus 13956914.114.9514.7
Child Fortune Plus3975315.5414.8312.81
Jeevan Saathi Plus3996511.1810.3612.23
Endowment Plus4042210.1710.2211.61
Wealth Plus402109.72N/AN/A
Note: NAV Correct as of Today August 25th 2012

Performance Summary of the above mentioned ULIP Plans:

Following are some points that were taken into consideration before arriving at the information below:
a. Only the Growth (Equity) Fund returns are used for comparison here
b. An Assumption that 1 lakh was invested on Inception date when NAV was Rs. 10/- per unit
c. No charges, fees etc are considered. I have assumed that the investor who purchased the policy got 10,000 units. This is because each plan has a different premium allocation charge, fund management charge, fees etc.
d. The net profit has been divided by the number of years the money has been invested in order to arrive at the average returns %.

Fund NameInception DateAmount InvestedCurrent ValueNo. of Years InvestedAverage Returns (%)
Profit Plus3929510000010990051.98
Fortune Plus3929510000011500053
Future Plus384121000002397007.418.88
Market Plus3889910000014590067.65
Money Plus390521000001161005.752.8
Market Plus 1396001000001351004.18.56
Money Plus 1395691000001410004.259.65
Child Fortune Plus397531000001554003.814.5789473684211
Jeevan Saathi Plus399651000001118003.23.6875
Endowment Plus404221000001017001.90.89
Wealth Plus40210100000972002.5-1.12
Returns Summary:
a. Returns > 10% - 2 schemes
b. Negative Returns – 1 scheme
c. Less than 5% Returns – 5 schemes
d. 5 to 10% Returns – 3 schemes

As you can see, around 50% of the schemes have given less than 5% returns and one of the schemes is in negative. Only two schemes have given us returns that we can smile about and there are 3 schemes that we can be partially happy about.

The returns themselves, without considering any fees or charges are pretty dismal. There are only two schemes that have returns that we can talk about. If we consider the fees and charges for those schemes, the net Returns % could come down to around the 5-8% mark. The other schemes that already have a single digit returns % may come down to 0 or even worse Negative.

So, what are these fees and charges?

The surprising part is that the LIC India website does not have fund specific charges clearly available for investors to see. I was able to find the details only for Endowment Plus. For now, let us assume that the fees for the other plans will be around the same range as this scheme.

Premium Allocation Charges:
a. First Year – 7.5%
b. 2nd to 5th Year – 5%
c. From the 6th Year – 3%

Fund Management Charges: 0.8% per year for the Growth/Equity Fund. Other plans too have a charge of around 0.5 to 1% per year

Policy Administration Charges: Rs. 30/- per month during the first policy year and Rs 30/- per month escalating at 3% p.a. thereafter, throughout the term of the policy.

What do I think about this?

Whatever we have seen so far is not something we can be happy about. If you are someone who has not invested in any of these ULIP Plans flouted by LIC, then you can heave a sigh of relief and say “Thank God”. (Trust Me, I am doing just that as I am writing this article)

If you are someone who was unfortunate enough to have invested in any of those pathetic performing schemes, then you need to really think and decide whether to continue with the ULIP or not. I wrote an article titled Should you Exit your ULIPs Now? in May 2012 and I suggest you read it and take a wise decision.

A fun trivia before we end this long article:
6 of the above 11 schemes are already withdrawn by LIC. In other words, you cant invest in them anymore.

Only god knows if the other schemes will be continued or they too will meet the same fate as their withdrawn cousins.

Happy Insuring Yourselves!!!

Friday, August 24, 2012

Public Provident Fund (PPF) De-Mystified

Public Provident Fund or PPF as it is more commonly called has been the staple investment avenue for thousands of Indians over the past two decades. Not only is it a good investment option, it also gives us tax benefits which makes it doubly attractive for an investor. We have covered the PPF as an investment option at a high level multiple times in this blog. Remember the articles covering Investments and Income tax like Best Tax Saving Options Available for Investment or Saving Income Tax through Investments?
The purpose of this article is to dive deeply into this great Investment Option. Lets get started!!!

What is PPF?

Public Provident Fund or PPF is a scheme that was introduced by the Government of India in the year 1980. Ever since that year, PPF has been a preferred choice for investment for the risk averse investor. Assured and Tax Free Returns make PPF even more attractive.

The PPF is just like the regular Provident Fund Account that salaried employees get throughout India. The only difference being, the PPF account can be opened by anyone and contributions can be made as per their preferences. The money saved in the PPF Account is backed by the Government of India and hence it is practically Risk Free. The money in the PPF Account earns interest just like the PF account which will be credited into our account by the Government.

What Makes PPF different from the Regular PF?

The Regular PF Account is available only for Salaried Employees in which case the contribution towards the PF Account will be made both by the Company where the person is working as well as the individual himself whereas, the PPF Account is available for anyone and everyone. It is available even for self-employed professionals or businessmen. The other difference is that, the contribution towards the account is made only by the investor and no one else.

Why Choose PPF?

There are multiple reasons as to why we must choose PPF as an investment option. Some are:
a. The Returns are Tax Free
b. The Money is backed by the Government of India. So, it is totally safe
c. The Investments made are exempt from Income Tax under Sec 80C (Up to 1 lakh per year)
d. One can open a PPF account in any bank or post office. Some banks even give us online options to open PPF Accounts through Internet Banking.
e. The Rate of Interest offered is very good. The current rate is 8.6% which is very good. The average rate of interest offered is around 8% which makes it above average returns for the risk averse investor.

If an investor contributes 1 lakh every year for 15 years, he will be left with around 31 lakhs at maturity (If the rate of interest goes at around the same 8.6% range). Your money has doubled at the end of 15 years which is amazing considering the fact that the money is totally safe and tax free.

If we consider the Tax Benefits that an investor will gain by investing in PPF along with the returns offered by PPF, the Returns work out to be more than 15% and would vary based on which tax slab the investor is in.

Some Key Points Reg. PPF Investment:
• PPF is a Long Term Investment Option (15 years Maturity)
• Maturity can be extended by an additional period of 5 years to make it a total of 20 years
• There is a minimum investment required every year (Rs. 500) to keep the account active
• There is an upper limit on the amount of money that can be invested every year (1 lakh) by an investor
• One Investor can have only one PPF Account. However, you can have one more in your spouse’s name without having to worry about tax liabilities even if the spouse is a home maker or has no income.
• If you have more the one PPF Account (In your own name), you need to close the others. When the other accounts are closed, there will be no Interest paid on the balance in the other accounts.
• Interest is earned on the PPF Account based on the minimum balance in the account between the 5th and the 30th of the Calendar month. So, if you contribute 10,000 towards your account on the 4th of this month, you will earn interest on it that month as well but if you invest on 6th, the 10,000 will start earning interest only starting next month.
• The interest is credited into our accounts annually (Once every year)
• Withdrawal is allowed once a year after the 6th year only and that too is only a % of your total balance. Full withdrawal is allowed only after the 15th year.
• PPF Accounts can be held or owned by only one individual. This is not like a bank account which can be jointly owned by two or more people
• The Balance in your PPF Account CANNOT be used as Collateral for loans that you may take
• Nominees can claim the balance in the PPF Account along with the interest accrued on the death of the account holder. The account has to be closed when the account holder dies.
• The PPF Account cannot be transferred from one person to another. Even in case of death of the account holder his/her nominee/legal heir cannot continue the account. They will be forced to close it.
• Loans are available against your PPF Money but the rate of interest has been hiked recently by the Government to discourage investors from dipping into their savings. The Government decides the Loan Rate every year just like the interest rate it pays to us.

PPF and Inheritance

We covered the concept of WILL and Legal Succession in one of our older post titled Have You Written Your WILL?. So, the question that arises now is what happens to the money in the PPF Account if the account holder died with no Nomination or WILL?

If the subscriber dies and there is no nomination at the time of death, the balance in the account, if it is up to one lakh, will be paid by the Accounts Office to the legal heirs of the deceased on receipt of application in Form G supported with necessary documents without the production of succession certificate. If the balance is more than one lakh, the production of Succession certificate will be necessary.

In a Nutshell, the PPF account is a great investment option for anyone residing in India. If we consider the Tax Benefits that we may get out of the investments into the overall returns, the number stands at an astounding 15% or more which makes it one of the best debt investment options available in India. Contributing a good amount into our PPF Account every year can help us build a good Nest Egg for retirement.

So, if you do not have a PPF Account now and are reading this article, Please go ahead and open one for yourself and make investing in the PPF Account a disciplined activity every month or year. You will not regret the decision at all…
Happy Investing!!!

Monday, August 20, 2012

Does your Wife Have Insurance?

Insurance – This is one topic that has been given a lot of attention in this blog. In spite of that, not many of us today still have the know-how to plan the insurance requirements of our family. Many people are under the impression that, Insurance is required only for the “Earning Member” or the “Bread Winner” of the family. Though this statement is not entirely false, it isn’t entirely true either. The purpose of this article is to analyze and find out if your Wife, who is the “Home Maker” or the more commonly used term “House Wife” needs Insurance…

Before we Begin – These days a lot of women, esp. in big cities are taking up lucrative jobs and hence they have access to financial advisors who teach them the importance of insurance. So, this article does not cover them. Our article here is going to exclusively concentrate on the “House Wives” of India who make up at least 70% of the female population in this country.

This article is not about Health Insurance. Health Insurance is Mandatory for every individual in the family irrespective of their age or what they do. So, don’t confuse the general term Insurance used in this article with health Insurance. We are only talking about Life Insurance.

Importance of the House Wife

In a country like India, the house wife contributes to the family/household in the form of cooking, educating the children and truck loads of other work. But, their importance or the value of the services they provide (In Monetary Terms) is greatly neglected.

Think this way, let’s say our Mother, who has been single handedly taking care of all household chores for the past 20 odd years is ill and cant do things that she used to up until a few weeks ago. So, you intend on hiring a maid, a cook, a cleaner etc. to help her. If you think of the monetary contributions we need to make to hire all these extra staff to run the family, you can realize the monetary worth of the contributions our Great & Sweet Mom has been doing for years without complaining even once.

We all know how much impact the loss of the home maker will have on families. The impact will be even worse if the family is in the low or the middle income earning group where they may not have the luxury to hire multiple people to help with the household chores.

Something that nobody can replace is the mental guidance and support that Mothers give their kids or that wives give their husbands. Unless we find a capable psychiatrist, this guidance and support will be greatly missed. This love and affection that the Mother or the Wife gives is priceless and CANNOT be replaced.

Does the House Wife Really Need Insurance

Let me start off by saying that NO ONE can replace a home maker mother and her loss will definitely have a significant impact on the rest of the family. To answer this question let us look at the things involved in the decision:

• Without a Mom at home, the child has to be left in a day-care center which would involve significant costs. This may not be easily feasible in low or middle income group families
• Without a Mom at home, we need a cook, a maid to take care of cleaning of the home, to take care of gardening work etc. The list will be pretty long and all these people will expect Salary in return for their services
• Without a Mom at home, children may need additional coaching (like Tuition) in order to excel in studies which again will require fees to be paid

Now, you ask yourselves the same question “Does the House Wife Really Need Insurance?”

I am sure the answer will be a Resounding YES.

Reason is pretty simple: The value of the services our mom gives to our family in monetary terms is incomparable. Every household activity will require a dedicated individual to handle it in the absence of the mother and they will expect a salary. In low or middle income families, this sudden onset of expenses may not be immediately feasible given the fact that the husband’s salary will not change by much immediately. So, at this scenario, if there was insurance, the family will at least have some surplus funds to utilize to try to bridge the huge gaping hole that the loss of the Mother leaves in a family.

Deciding the Value of Insurance for the Home Maker

There is a term called Cost Replacement Analysis in finance that can be used to calculate the value of something or someone for a certain duration. Simply put, you will calculate how much money is required to run the family in the absence of the Home Maker on a per month basis and then multiply it by 12 to get the annual number. Finally you multiple this by 10 or 15 in order to arrive at the figure that will be required for the next 10 or 15 years. This should be the monetary value of the Insurance that the Home Maker will need.

Some Last Words:

Proper Financial Planning is essential for any family. Open discussing and fairly calculating the insurance or investment requirements will not only build a prosperous family, it will also cultivate better understanding between the family members. The Home Maker is an integral part of any family and CANNOT be replaced. In their absence, the family has to try to keep going because life doesn’t stop. However, insuring the home maker will give the family the required monetary cushion to absorb the impact and try to recover from the devastating loss.

Happy Insuring!!!

Saturday, August 18, 2012

Bad News for Insurance Investors and Agents

Oh yes, you read the title right “Bad News for Insurance Investors”. You may be wondering over the fact that I have used the term “Insurance Investor”. If you have read the other insurance related posts in this blog, I have always been an ardent advisor of the fact that Insurance and Investment are two different entities and should not be clubbed. But, now I have used the term Insurance Investor which is kind of misleading isn’t it?

Don’t be confused my dear friend. The purpose of this article is to share some bad news for all those Indian citizens who have taken Insurance Policies as Investment options.

Why this Article

This article was written for multiple reasons:
1. Indians are one of the very few people who actually buy Insurance policies for Investment
2. Our fathers bought LIC Policies as investments, they advised us to do the same and still feel that Endowment Policies from Life Insurance Companies are the best investment options
3. Insurance Sellers (Agents) are notorious creatures who have been selling all the products that are beneficial to them (while it should’ve been beneficial to us) by wrongly stating the facts.
4. The IRDA wants to ensure that the interest of the normal insurance investor is protected

So, what is this Bad News for Investors?

The Insurance Regulatory and Development Authority (IRDA) has proposed certain changes to Endowment life insurance policies which will greatly affect the common investor who buys insurance products for investment. The Bad News is:

Bad News No. 1: Going forward, big annual bonuses will no longer be paid out.

Why: IRDA has proposed that a minimum death benefit must be set on Endowment Insurance Plans. This means that, in order to accommodate this minimum death benefit the insurance company will be forced to cut-back on the annual bonuses to the policy holders

Impact on Agents: One of the main selling points for Endowment Policies from the Agents mouth is the fact that we will get big fat loyalty bonuses every year for investing. So, if this is not going to happen, their biggest trump card is trumped out…

Impact on Investors: The Bonuses are the reason why the overall returns of Endowment policies try to creep upwards around the 6-7% range. So, if bonuses are cut-back, then the eventual returns from your endowment policy could be lesser than 6%.

Bad News No. 2: Insurance Premiums are set to go up

Why: As a result of the above news, Insurance Cos will be forced to set minimum death benefits for their customers. The current premium rates are not at that level. So, in order to accommodate the higher final values the premium will have to be hiked by the Insurance Co's (Unless they want to go bankrupt)

Impact on Agents: Not Much. Instead of the earlier X amount premium they are going to ask the customer to pay up X + Y amount.

Impact on Investors: The Annual Premium for the same policy with the same maturity amount is set to go up significantly and it will vary based on various factors like the Investors Age, Insurance Co, Policy Term etc

Is this Really Bad News?

Actually speaking – From the Customer point of view, No. This is in fact good news for the customer who buys these policies for the purpose of Insurance. Since the amount of insurance he gets out of these policies is higher, it will be beneficial for his family after their time. So, isn’t this good news? If we think from only the insurance stand point of these policies?

What is this Minimum Death Benefit?

This is the minimum amount an Insurance Company has to pay the policy holder in case of an untimely death when the policy is in force. The number will be calculated as follows:

For individuals who were less than 45 years old when they signed up for the policy:

Of the following – whichever is higher will be paid

1. 10 times the annual premium or
2. Half the Annual premium multiplied by the policy term or
3. 105% of all the annual premiums paid

For individuals who were older than 45 years when they signed up for the policy:

Of the following – whichever is higher will be paid
1. 7 times the annual premium or
2. 25% of the Annual premium multiplied by the policy term or
3. 105% of all the annual premiums paid

What is this Bad News for Agents?

The IRDA has proposed upper limits a.k.a caps on the commission paid out to agents for selling endowment policies. Endowment policies are one of the highest commission paying policies available for agents and hence they sell it like hot cakes. The IRDA has suggested that:
a. For all policies with tenure of 5 to 9 years, the first year commission cannot be more than 14% of the annual premium
b. For all policies with tenure of 10 to 14 years, the first year commission cannot be more than 28% of the annual premium and
c. For all policies with tenure of 15 years or more, the first year commission cannot be more than 40% of the annual premium

Why: IRDA Feel that misselling of insurance products happens predominantly due to the commission that agents earn by selling a particular policy. So, by establishing an upper limit on the money an agent earns by selling a particular policy, IRDA aims at reducing this misselling.

Impact on Agents: Commission Income is the only income that Agents get by selling a particular policy. So, if the commission they get out of selling a particular product is less, they will probably not advise a customer to buy it, if it wont be beneficial to the customer

Impact on Investors: The commission is actually paid from the money we pay as premium. So, lesser the commission that is paid, the more the actual money from our premium that gets invested. So, this means that a bigger portion of our money will get invested and hence a slightly higher returns can be expected.

Final Verdict:

I have said this numerous times and will say it again – Insurance Products are taken for the benefit/use of our family members after our death. If you want to use the money you pay as premium towards your policy before your time, invest that money in other investment options like Shares, Mutual Funds, Bank Deposits etc.

Did you know the average returns an Endowment Policy gives to its customers? You will be shocked to know the fact that it is only 6% on average. This is at least 2% less than a Bank Fixed Deposit and other investments like Shares or Mutual Funds may give you even double digit returns.

So, if you are satisfied with below average returns (Only 6%) then please go ahead and Invest in Endowment Life Insurance Policies.

Happy Insuring Yourselves!!!

Thursday, August 16, 2012

Returns Comparison – NPS Vs. ULIP Pension Plans

The previous article was an analysis of the performance at the end of 3 years of the National Pension Scheme a.k.a NPS in India. Towards the end of the article, I had said that, I will post a returns comparison between the NPS and a regular ULIP Pension Plan. So, here we are…

Before we begin: Be prepared for the Shock of your Life when you actually see the number comparisons!!!

Let us say You and I are good friends and decide to invest Rs. 1 lakh every year for our retirement for the next 25 years. You spoke to an investment advisor who has convinced you to select a fantastic ULIP Pension Plan which he says is going to give you absolutely fantastic returns while I decide to invest in NPS Instead.

So, what will our investment be worth at the end of 25 full years?

To arrive at that number we need to make a few assumptions before hitting the calculator. Don’t worry, you don’t need to perform any calculations. I will do it for you and give you all the numbers.

a. Both of us invest the same fixed Rs. 1 lakh for 25 years making the total investment of 25 lakhs each
b. Both investments are going to give a uniform 9% rate of returns
c. Fund Management fee is payable as a % of the corpus. 0.25% for NPS and 2% for ULIP Pension Plans
d. Premium Allocation Charges is payable as a % of the amount invested (Freshly) every year. 0.25% for NPS whereas the Pension fund charges a Premium allocation charges as follows – 30% in the first year, 20% in the second and 10% in the third. After the third year they charge a flat 2% for all the remaining years

So, if we include all the above information into the calculator, the details workout to be as follows:

As you can see, my investments are worth 88.23 lakhs at the end of 25 years while your investments are worth 61.74 lakhs. A difference of over 25 lakhs which in fact is the amount that we both invested.

Why the Difference?

1. Difference in Fees/Charges – I Paid a flat 0.25% premium allocation charges and another flat 0.25% fund management charge whereas the numbers were much higher for the ULIP Pension Plan
2. I Paid a flat Rs. 250/- every year as Premium Allocation charges which works out to a total of Rs. 6,250/- for 25 years while you paid varying Premium allocation charges that work out to a total of Rs. 1,04,000/- for 25 years which is approx. 16 times what I paid
3. I Paid a flat 0.25% fund management charge (As a % of the total corpus that was being managed) to the fund house every year that works out to Rs. 1.81 Lakhs
4. Though your fund management charge was fixed at 2% per year, the total amount you ended up paying was Rs. 11.91 Lakhs
5. You paid approximately 12 lakhs more than what I paid as fees and this extra amount that got invested against my name too resulted in additional returns

If you want a Year on Year returns comparison between your ULIP Pension Scheme and my NPS, see the tables below:

ULIP Pension Plan Returns:

NPS Returns:

A Word of Caution:
The NPS is governed by the Government of India while ULIP Pension Funds are governed by the respective Insurance Company. So, technically speaking the returns in a ULIP may be 1 or 2% higher than the returns generated by NPS. But, the difference in terms of returns may not be more than 1 or 2%.

This is a big May Be because the Government is closely monitoring the performance of the NPS Schemes and hence, even this 1 or 2% difference too is highly unlikely.

Some Last Words:
Do I need to say that NPS is a better investment option than ULIPS? The main reason being extremely high charges in case of ULIPs. Why pay 12 lakhs to the ULIP Company to manage our money while an almost similar option is available at a much cheaper rate???

Happy Investing!!!

Is National Pension Scheme (NPS) A Worthwhile Investment Option?

Around a year and a half ago, I wrote an article titled The National Pension System – De-Mystified in which we had taken a detailed look at this National Pension Scheme (We will refer to this as NPS throughout this article) that the Government of India started in 2009. A few days later there was a subsequent article titled National Pension Scheme - All your Questions Answered!!! in which I had tried to answer our blog readers questions on the NPS. It has been over 3 years now since the Government of India started the NPS. The purpose of this article is to analyze if the NPS Schemes have lived up to their expectations and the future course of action for the Indian Investor

How the Different NPS Fund Houses have performed over the Past 3 years

As outlined in the article introducing the NPS, there are several Fund Managers that an investor can choose from when he/she opens the NPS Account. Each of these fund managers may choose to invest in a different set of instruments and hence the returns will not be uniform. As a general categorization, the NPS Fund Managers manage 3 categories of funds in Tier 1:
a. Category E – Equities
b. Category C – Corporate Bonds
c. Category G – Government Securities

Different Fund Managers have performed differently in each of the above categories. After gathering details about the performance of each of the different fund managers, I have shortlisted the best or rather top 3 performers in each category over a 3 year time period. They are:

Equities – Category E Funds:
1. Kotak – 6.82%
2. ICICI Prudential – 6.43%
3. IDFC – 4.98%

Category Average Returns = 5.58%

Corporate Bonds – Category C Funds:
1. Kotak – 12.05%
2. ICICI Prudential – 11.59%
3. IDFC – 9.24%

Category Average Returns = 9.97%

Government Securities – Category G Funds:

1. Kotak – 7.95%
2. ICICI Prudential – 7.7%
3. UTI – 7.5%

Category Average Returns = 7.32%


All returns above are over a 3 year period. Don’t be amazed by the dismal returns generated by the Equity funds. The Indian stock market has been extremely volatile over the past few years and a positive returns % indicates the fact that the fund managers have done a great job.

As you can see, the funds managed by Kotak and ICICI Prudential have been the top 2 in all of the categories.

Is the NPS Scheme Popular?

The simple answer would be – NO

If you wish to dispute this claim and say that NPS is popular, stop for a moment and give me an answer to this question – “Do you have an NPS Account?” The answer you will give in response to this question is the answer to the question above as well…

Problem No. 1: Have you seen any advertisement by any fund house about the performance of their funds in NPS? For ex: the schemes managed by Kotak Pension Fund have churned out the best possible returns in all the 3 categories. ICICI Pru has been the 2nd best performer. So, given this fact, have either of these two fund houses advertised their success? This whole phenomenal success has gone almost unnoticed. Nobody publicized the fact that their schemes in NPS were successful. Whereas, the same Kotak and ICICI Pru fund houses always advertise their best performing Mutual Fund Schemes. Why this disparity???

Problem No. 2: Have you seen anybody trying to sell NPS Schemes to investors? The NPS has approx. 25 lakh investors out of which almost everyone is from State & Central Government for whom NPS is compulsory. The distributors are not selling NPS at all. In fact, less than 50,000 people have voluntarily invested in NPS in the past 3 years. Why do you think this is happening?

Why Fund Managers are not advertising their Schemes in NPS?

The simple answer is – MONEY!!!

The fees that fund managers receive for managing the NPS schemes is nothing short of dismal. The fund management charge is 0.0009% which means, a fund manager get Rs. 9/- for managing Rs.10,00,000/- for one year. The average fee for managing a similar number in Mutual funds works out to a 4 digit number and the same for ULIPs is a 5 digit number.

Why Distributors are not selling NPS Schemes?

The simple answer to this question too is – MONEY!!!

I could not find the actual commission/fee that Distributors get for selling NPS but I would assume it will be around the same range as what the fund managers get. If the fee the person who manages the money (Fund Manager) is only Rs. 9/- for a 10 lakh investment, what do you think the distributor will get for selling NPS Schemes? Distributors feel that the profits they earn out of selling this low-cost scheme does not justify the amount of money or resources that go into selling it.

What is being done to fix this?

The PFRDA has been contemplating increasing these fee & commission charges that the distributors and fund managers receive for dealing with NPS. Hopefully this upward revision of fee will be the much needed boost to both the fund managers as well as distributors to take NPS Seriously.

However, a point to note here is that, no concrete numbers have been released by the PFRDA yet. However, it is expected to come out very soon. But, experts from the industry feel that the number would be around 0.25% (Rs. 2,500/- per Rs. 10 lakhs) which is a sizeable increase when compared to the current dismal figures.

Will this affect the Investor?

Of Course, it will. However, the impact will be almost negligible. Mutual Funds charge around 1-2% per year and ULIP’s charge even more. If we consider a 0.25% fee for the fund manager and the same for the distributor, for every 10 lakhs you invest, 9.95 lakhs is going to be effectively invested which is much higher than what happens in the case of Mutual Funds or ULIPs. So, it is safe to say that the impact will be very minimal.

How Increasing the Fee’s will help?

First of all, if the fee fund managers get is reasonable for the effort they spend managing the money, they will start advertising the fact that they are managing X Crores of money for NPS. Second of all, if distributors can make a reasonable income by selling NPS products, they will start advertising as well as selling NPS Schemes to investors. So, it will be a WIN-WIN Scenario.

Is National Pension Scheme (NPS) A Worthwhile Investment Option?

Of Course – YES.

Frankly speaking, the NPS Schemes are managed by the same expert fund managers who manage the top mutual fund schemes of India. So performance wise it would be safe to say that NPS schemes will fare at around the same level as regular mutual funds.

More importantly, the fee’s charged by NPS is the least in the industry. Even if we assume a 0.25% fund management fee and a 0.25% distributor fee, the overall fee’s paid works out to less than 1%. The fees and charges for Mutual Funds and ULIP’s or other Pension Plans is much higher. So, effectively more of our money will get invested and in turn, we will get better returns.

To further substantiate my claim that NPS is a better investment option than a ULIP Pension Plan – due to the lower fee structure, the next article is going to be a comparison in terms of overall returns between the NPS and ULIP Pension Plans.

If you are still not too sure if the NPS is a good investment option in comparison to the regular ULIP Pension Plans that are being sold aggressively, just relax, the feeling is very common. The next article will be a simple returns comparison between the two products to help you decide...

Happy Investing!!!

Wednesday, August 15, 2012

Children and Pocket Money

A few months ago, I had written an article in this blog titled "Children & Money – Can We Teach Our Kids about Finance & Money Early?" about educating our children about finances. It is always a good idea to start financial education early. Home is the first place where kids learn about finance and as parents it is our duty to teach our kid the important aspects. The starting point of financial education for any child is “Pocket Money”. In the Indian tradition, whenever kids take the blessings of adults during auspicious occasions like festivals, the most common way of showing love or blessing is by giving children cash. This article is not going to cover that aspect. We are only going to talk about the regular pocket money that we as parents will be giving our kids…

Before we begin – During Festivals and auspicious occasions, kids usually collect at least a few hundred rupees when they get the blessings of elders. It would be a good idea to buy fancy piggy banks to the kids and motivate them to deposit that money into the piggy bank. For a child that hasn’t reached at least 15 years of age they do not have the know-how to spend that kind of money. So, the best option for the child is to save that money. As a Parent we must not touch the child’s savings. Make sure you open a bank account in the child’s name and deposit this money periodically into that account. DO NOT touch that money. It is the kid’s hard earned money not yours!!!

Ok, coming back to the topic of “Pocket Money”, this not only does pocket money give kids their much needed financial independence, it also offers us our first and probably the best chance to teach them the value of money. Below are some suggestions about this extremely important topic.

Step 1: Decide When to Start

Deciding when to start giving a kid his/her pocket money is the first step. Do not give money into the kid’s hands when it does not know how to differentiate between the different currency note or coins. This usually happens when the kid is around 7 to 8 years of age. So, wait until your kid is around 8 or so in age and then start giving the pocket allowance.

If you feel your kid is not ready to handle the money you have all the right to delay the start of this pocket money thing. Just because your child is 8 years old doesn’t mean he needs cash. Be a responsible adult and take a wise decision. Do not be in a hurry to hand out cash to your kid.

Step2: Fixing the Allowance

Young children almost always spend their pocket money buying candies or items to eat on their way to or from school. As they grow older their needs and interests vary and their spending pattern too will vary. So, as parents we must fix the allowance that wouldn’t be too much to spoil the kid but at the same time not too little to make him uncomfortable.

Example Age-Wise Split:
a. Less than 8 years
b. 9 to 12 years
c. 13 to 15 years
d. 15 to 18 years
e. More than 18 years

Just like at work where people are given mandatory promotions at the end of a certain number of years, it is extremely vital that you give them mandatory increase in pocket money when they move over from one age group to another.

Step 3: Fix the Frequency

Another important consideration is how frequently you are going to give the allowance to your child. Younger children usually spend all their allowance within one or two days of getting their hands on the cash. So, it would be advisable to start out with smaller amounts and higher frequency like Weekly. As they grow older and learn to handle their finances well, you can reduce the frequency to say once in two weeks or monthly.

Decide the Frequency and Amount sensibly. Kids these days grow up in Apartment’s and gated communities where there are multiple kids of the same age group. So, talk to the kids of the other parents and find out how much they are offering as allowance. Make sure to keep your number as close as possible to the general average. If the average is Rs. 200/- per month for the kids in the 10 to 12 year age group in your colony, you can decide to keep your number at say Rs. 50 or 60 per week. You need to also ensure that you don’t give them too much cash to flaunt. Flaunting cash is not a good habit and may be a hindrance in the child’s future as well.

Step 4 – Monitor the Spending’s

The whole idea or purpose behind giving the kid an allowance is to provide them with financial freedom so that they can hone their skills at handling money. Don’t be a micro-manager. Let the kid decide what or how they want to spend their money. Your job is to set the ground rules like the Do’s and Don’ts. Once you establish the ground rules don’t trouble them excessive questions or pointers. Kids are bound to make mistakes. Don’t punish them for that. Instead teach them what they did wrong and help them understand the right way of doing things.

Financial Freedom does not mean uncontrolled or unmonitored spending’s. Make sure that you know what your kid is doing with the money you give them. It is extremely vital and important to ensure that your kid is not indulging in bad habits like gambling or drugs or cigarettes etc. The list of bad habits that are tempting to the adolescent youngster is endless. As parents it is our bound duty to do what is best for our child. So, never lose track of what your kid is doing…

Step 5 – Do Not Bail Them Out Financially Unless it is Extremely Essential

As I said before, kids will make mistakes. After all, even grownups make wrong choices when it comes to finances. So, we need to realize that during the first few months of their new found allowance kids will lose money or spend it on things they don’t need or exhaust their allowance within the first couple of days in the week etc. At such times, don’t bail him out. For ex: If your kid’s weekly allowance is 25 rupees and he treated himself to a cornetto and spent 20 of the 25 rupees on day one and has almost nothing to spend for the remaining 6 days of the week. So, he may come back to you for additional cash. As parents it may be hard to see our kid suffer financially but if you bail him out and refill the additional 20 rupees today, he will never learn to be responsible and be a spend-thrift throughout his life. Let him spend the next 6 days on the 5 rupees he has at hand, the next week onwards he will think and plan his spends so that the money you give him will last the whole week…

On the other hand let us say he lost his money somewhere on the way back home and is stuck and calls you for help, it is your duty to go and bail your son out because he did not do it on purpose. Even adults lose their money once in a while and kids may do it even frequently. If you help him out, make sure to give him some tips on keeping his allowance safely. It will help him be more cautious the next time around.

Dads are usually stringent when it comes to money matters. It is the Mom who is the “AkshayaPatra” for kids. I have done it, you have done it and in all probabilities our kids will do to. But, have a frank talk with your wife about the topic of money. Ask her to take a judgment call about handing out cash to the kid. Let the kid not sweet talk her into giving him additional money regularly. Though mom’s are always sweet and eventually give-in more often than dad’s they must also learn to say No. At least during the first few years of the child’s financial education.

Some Additional Tips:

The following are some additional tips to help you handle your kid’s financial education:

Tip 1: Don’t offer money to kids for doing house-hold work like Cleaning up the Garden or Terrace or Visiting the Grocery store etc. Those are duties of every individual households and not money making opportunities.

Why: Offering cash rewards every time your kid does something for the house will set a bad example and the child may start expecting to be compensated for every minor errand he/she may do. This is not correct. They are part of the family and should not be doing stuff for money

Tip 2: Don’t punish them for bad behavior by cutting on the allowance. Find other means to discipline them.

Why: Good Behavior is something every child needs – irrespective of the allowance they get. If you cut their allowance because they misbehaved, they may mend their ways just for the money involved. Do you really want your kid to be well-mannered just in front of you so that he will get his full allowance and misbehave with everyone else? This is what will happen if you touch their allowance to punish them. There will be little or no behavioral improvement.

Tip 3: Don’t interfere in borrowing or lending among friends

Why: Teenagers borrow and lend money frequently and it is extremely common. So, as parents we need not involve in all those matters. But, as a general suggestion we can advise our kid against the pitfalls of excessive lending or excessive debt so that they can be cautious.

Tip 4: Teach Kids the Habit of Saving – Give him a Piggy Bank and if possible a Bank Account

Why: The first paragraph in this article about kids getting money from elders is very true in India and I am sure you will agree to it. Let us say it is Diwali and your son gets to meet both his grandparents, all of his uncles, aunts etc. and goes on a “Bless Me Please” spree, he will probably collect at least a few hundred rupees or maybe even a four digit number. In such cases, teach your kid not to go on a shopping or spending spree with his new found wealth. Teach him the importance of saving for the rainy day. Tell him to start saving this money for something he has been asking you for a while; say a new Bike or a new Cricket Bat etc.

If he child realizes that spending money is easy and saving it is difficult, he will not take irresponsible financial decisions in his future.

Some Last Words:

The whole purpose of this article is to cultivate financial discipline and wisdom among kids right from a very young age. Almost all of us these days are in the “Working Class” and we have had to work our backsides off to come to the stage we are in right now. As parents it is an admirable trait to think that, I do not want my son or daughter to go through the financial hardships that I had to go through when I was young. But, if you spoil your kids for choice, they will not realize the value of hard work or money. Do we really want our kids to become that typical rich brat who causes trouble in random places and gets beat up by the hero in movies? You will definitely say that, the guy’s wealth and access to easy money is the reason why he is so spoilt. I am sure you don’t want that to happen to your kid, do you???

Be a responsible parent and teach the good things to your child.

Happy Financially Educating the Next Generation!!!
© 2013 by www.anandvijayakumar.blogspot.com. All rights reserved. No part of this blog or its contents may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the Author.


Popular Posts

Important Disclaimer

All the contents of this blog are the Authors personal opinion only and are not endorsed by any Company. This website or Author does not provide stock recommendations. The purpose of this blog is to educate people about the financial industry and to share my opinion about the day to day happenings in the Indian and world economy. Contents described here are not a recommendation to buy or sell any stock or investment product. The Author does not have any vested interest in recommending or reviewing any Investment Product discussed in this Blog. Readers are requested to perform their own analysis and make investment decisions at their own personal judgement and the site or the author cannot be claimed liable for any losses incurred out of the same.