World Champions

They proudly stand on the podium,

The whole world worshipping at their feet.

They have been anointed Champions.

The prize is much more than laurel wreaths.

 

Theirs is money, fame, adulation,

The high of instant recognition.

It's not only their chosen profession

but to all to whom it's religion.

 

A million flashlights trained on them

In form of million adoring eyes.

All till the next tournament comes,

when they will turn off, all at once.

 

We want our Gods to have a shelf life.

Worship too, like everything else

is extreme. Short. In tune with the times.

We like to discard and move on.

Paul the Octopus / The Soothsayer

Paul the Octopus predicted the German team's fate correctly 6 times on 6.  If you think this makes people happy, think again!

He was a darling in Germany till now - he predicted they would win, and they did.  Once his prediction about the defeat to Spain came true, people seem to be blaming him for the defeat! .  Security around his tank in Germany has been enhanced since he has been receiving death threats. Several Argentinians too want to cook him and eat him for dinner.




We look to omens of every kind
To foretell the future for us.
Clutching at any straw we find
To suppress our dread.

Scared of what tomorrow will bring,
We convince ourselves it will be good.
Oh, Soothsayer! Tell me all will be fine,
It's what I want to hear.

Seldom are those who foretell bad things
Liked, specially if they come to pass.
It's not the truth that we want to hear,
What we want is a salve.

The fear of death forever haunts us,
Or all we have being snatched away.
We flounder, in search of vain hope
Which keeps death at bay.

No soothsayer would tell the truth
If he really had the power to see.
No one wants to know. We just want hope
In face of adversity.

No soothsayer should predict our deaths,
We will die every day till it comes.
Our whole lives are spent running away
From the one thing that is certain.

Part 16: Tax

Apart from death, the only thing that is certain is that we will be taxed! That is at least true in most countries of the world, including in India. We shall look at what are the few ways in which salaried individuals can save on paying taxes, but we first need to know the provisions of the Act (Income Tax Act) broadly as they apply to us. 

How much tax are you liable to pay? To estimate this, you have to list all your income for the Financial Year (April 1 to March 31) first. Under the Act, your income would fall under the following categories:

Income from Salaries: Salary, Pension, and any payment arising from an employer-employee relationship

Income from Business and Profession: We shall not be covering this. For the purpose of this article, we shall assume that our primary source of income is from salary, and apart from rental income or bank interest and dividends, there are no other major sources of income. 

Income from House Property: Rental income

Capital Gains: The profit or loss arising out of selling an asset – the sale price less the original cost (“indexed original cost” in some cases) is the Capital Gain on sale of a particular asset. Asset includes house, land, shares, jewelry even if it is part of one’s personal effects, securities, units of Mutual Fund, and all other kinds of assets which are not “personal effects”.

Income from Other Sources: Any income that does not fall under any of the four heads above, will figure here. Includes income from interest on bank deposits, accrued interest on NSC’s and FD’s, income from lotteries, anonymous donation and any money that falls from heaven.

Agricultural income is exempt from tax.  Dividends from Equity Shares and Mutual Funds are exempt from tax – they have already incurred dividend distribution tax at the point of distribution.

Worldwide income is taxable – if you have any income from sources outside the country, that has to be included.  In case you happen to be working or settled abroad, different provisions may apply, but we shall not be covering those in this article.

The way it works is that all that you earn is liable to tax unless it is specifically exempt. So if you are in doubt, you can assume it is taxable!  There are  specific exemptions available under the relevant heads of income which we shall look at. All provisions related here refer to the Financial Year 2010-2011 (relating to your current income for which you shall be filing returns in the next financial year, by July 31, 2011), and this article merely touches upon some of the more relevant provisions for a salaried individual resident in India – it is by no means complete – we recommend you contact your tax advisor when it comes to your specific issues and queries!

Your annual income will be taxed in the following slabs:

Up to the first Rs.160,000: Nil – In case of women (who are not senior citizens) this amount is Rs.1,90,000. In case of senior citizens above 65 years of age this amount is Rs.2,40,000.

160,000 (or 1.9 lakhs or 2.4 lakhs) to 500,000: 10%
500,000 to 10,00,000: 20%
Above 10,00,000: 30%

There is an educational cess of 3% that is added to the tax amount.  Thus the highest marginal tax rate for an individual is 30.9%.

Income from Salaries

Let us have a detailed look now at “Income from Salaries”.  All amounts that are received from the employer or a former employer are taxable including salary and allowances in all its forms, bonus, gratuity, pension, etc.  There are a few specific provisions for exemptions on items that generally form part of your pay package that we can now look at.

House Rent Allowance (HRA): The least of the following is exempt:

1. Actual rent paid less 10% of Basic Salary
2. 50% of Basic Salary (in case of Mumbai, Delhi, Chennai, Calcutta) – 40% of Basic Salary in all other cases
3. Amount received as “House Rent Allowance” which forms part of salary

In effect what it means is that you get exemption for any rent that you pay in excess of 10% of your Basic Salary. If the rent paid is claimed by your spouse in his / her salary or if you don’t live in a rented accommodation, then the entire HRA amount is taxable in your hands.

Provident Fund: You pay 12% of your basic salary as contribution towards your PF which is deductible under Section 80C (more on 80C later). The employer contributes an equivalent amount – this amount contributed by the employer is tax-free - it is directly deposited into your PF account and you cannot withdraw it except under certain conditions.  This money earns interest at the rate declared by the Government every year – currently, it is 8.5% tax-free.  You get to withdraw the accumulated sum on retirement fully tax-free. There are certain conditions under which you can avail of loans against your PF balance, but it would be in your interest to let the corpus grow and not touch it till you retire.  Which other investment gives you an exemption in tax at the time of investment, an exemption on Interest earned, and a full exemption on withdrawal? By the way, what we just described is called the E-E-E model.

Superannuation Fund contribution (SAF): The employer can contribute up to another 15% (over and above the 12% to PF) to the Employee’s Superannuation Fund. This amount does not require a matching contribution from your side.  It is tax free up to Rs.100,000; the balance amount is taxable. Obviously, since it enjoys an exemption, there are certain conditions attached. The corpus is invested by the trust either by itself or through LIC through a fund set up for this purpose. The returns that the fund gets every year are added back to the corpus of the holders, and these yearly accretions to your account are tax-free. At the time of retirement or superannuation, you can commute one-third of the amount, i.e., get one-third of your accumulated corpus in cash tax-free. The balance two-thirds has to be invested in buying an annuity that will start giving you pension after you turn 60.  The pension, by the way, when you start getting it, is fully taxable as your income. So the SAF can be said to be following the E-E-T model.

Staff Transportation provided to-and-fro between office and home, is fully exempt though it is a perk that the company provides to you.  In case the company does not have this facility and gives you a transport allowance instead, such allowance is exempt up to an amount of Rs.800 per month.

Meal Coupons (Sodexho or Ticket Restaurant) that the employer provides to you, and/or meals provided at company expense at office, are tax-free since there is a provision in the Act which exempts such payments up to the limit of Rs.50 per meal.

The premium on Medical Insurance and Life Insurance which the Company pays is exempt from tax.

Employee Rewards / Awards are taxable if the amount exceeds Rs.5000 per annum.

Some companies have Medical Allowance and Leave Travel Allowance on which tax exemptions can be claimed. Against your medical allowance you can claim up to Rs.15,000 per annum tax-free on production of medical bills for treatment of self and family. Against your Leave Travel Allowance, you can produce tickets and proofs to claim travel expenses tax-free twice in a block of four years, for going on vacation with family. The amount eligible is economy class air fare. However, these two provisions are highly prone to misuse where people produce false claims, and there is a heavy onus placed on the company to ensure sufficient safeguards. Several large companies do not have these two allowances as part of their pay – they prefer to gross up the tax and include the amount in the pay, rather than take a risk with false claims.

We shall discuss more on Tax in the next issue.  Bye till then.

Part 15: The Minefield called Insurance

Why do we pay more for fruit salad when we can get each of the individual fruits cheaper?  It’s because of the perceived value-add that the vendor offers of cutting it up and mixing it together. Would we still pay more if we knew that mixing different fruits may actually be harmful to the health?

Why do we pay more for “combination” drugs when the same medicines bought individually would be cheaper?  Take the simple example of Combiflam.  It’s nothing but Ibuprofen (an anti-inflammatory) and Paracetamol (analgesic, antipyretic) – so why not buy Crocin which is Paracetamol, and Brufen which is a brand of Ibuprofen? The market is flooded with various combination drugs, some of which have superfluous dosages; some combinations actually counteract the effects of each other; and in some cases, the combinations are plain dangerous. Why do we still buy them? Why do we ignore any article we come across which tries to explain this?  Is that because somewhere in our mind we want to believe in the efficacy of a wonder drug which will be a miraculous panacea for all ills? We do not really want to know what it consists of – deconstruction and demystification puts on us an additional responsibility of understanding what we are consuming, and by extension, taking responsibility for our own health.  We would rather pay someone for a magic pill and believe in it with a fond ignorance. 

And who is that someone who prescribes it to us?  The Doctor who is supposed to be the expert in whom we repose blind faith.  We go to a big hospital even for a small illness, and are very happy undergoing a round of mostly needless tests to reassure ourselves that we have not ignored anything potentially life-threatening. We take whatever medicine is prescribed without checking on what each of them is for, and what the side effects are likely to be. We ignore what we know to be a fact – that in a lot of cases, the doctors too have targets – they need to keep the rest of the hospital running with their cross-referrals. We do not want to know about the kickbacks they get from each of their prescriptions. We over-test, over-medicate, and over-pay without checking the facts - in fact we consciously ignore the facts. Why would we do that?

When we buy financial products it is no different. In actual fact there are only a few categories of financial products – what is relevant to us is Stocks or Equity, Fixed Income or Debt, Real Estate, and Gold or Silver.  Assuming you don’t want to invest directly in Equity, what you need to do is invest in Equity Funds, Debt Funds, Real Estate, and Gold or Silver.  Each of these Asset classes has its own characteristics and has different risk and return profiles. The problem starts when the marketers start combining these together in magic pill products that will solve all your life’s problems – like take care of your retirement, get your daughter married, make sure your son becomes a doctor.. for each dream there is a product. In most cases these products are bundled with Insurance. Not only will your son become a doctor but he will do that even in the “unfortunate event” something happens to you!  Have you ever stopped to consider that the guys who sell you these dreams have no choice but to take your money and do the following (1) Deduct a mortality charge from it for the insurance part in case it’s an insurance product (2) Deduct a commission for the agent who sold you the product (3) Invest the balance in Equity, Debt, Gold ETF’s or a mix of the above.

So what’s the harm?  They are doing what you would have done yourself, aren’t they? Do you know how much they deduct for the mortality charge? Do you have any idea of how fat their commissions are? Do you know that the commissions are calculated as a percentage of the total premium, the major portion of which is actually meant for you to save? Do you know they have several more charges hidden inside like (in case of insurance products) Premium Allocation Charge, Policy Administration Charge, Fund Management Charge,  Administration Charge, and We-will-not-tell-you-what-it-is Charge?

Do you even know what the charges are? Do you know that some charges are so hidden from you that they get deducted from the NAV of your fund without your knowledge? Have you ever seen a single statement from an Insurance Company describing to you what the exact charges were and how your investments have fared month-on-month, like any Mutual Fund does?

Did you know that in the year 2009 the entire premium collected by the Life Insurance Industry in India was about Rs.200,000 crores out of which Rs.14,000 crores was paid as commission?  That is seven percent. The same as what a bank deposit yields you. And you would still trust your savings to an insurance company?

There is more.  Did you know your friendly banker who claims to be your “financial doctor” is working for a bank which has given him targets to sell those products which yield the maximum commissions?  Why do you think he never advises Term Insurance? Why do you think he mixes up insurance and savings in the first place? He is an MBA from a premier institute and he obviously knows his stuff.  His knowledge may be excellent but what are his motives?

Do you know major insurance companies have tie-ups with the banks to push their savings-cum-insurance products?  Do you think it is in their interest to educate you about your finances?  Then why do you listen to them when they peddle ULIPs or Pension Plans and all other kinds of bundled financial products?  Because you don’t want to take the trouble of being better informed?  Or because you don’t want to confront them because you don’t have adequate knowledge to counter what they say? Or you are looking for that one magic pill which promises to end your life’s problems – as your friendly banker is talking to you, you see visions of spending your retired life ensconced in luxury, enjoying sybaritic indulgences – all you have to do is hand over your money to him and he will take care of the rest?

Your friendly insurance agent is no different of course.  Except that several times she is the wolf who comes in the garb of a well-meaning aunt.

And you are Little Red Riding Hood.  How quaint.  Bye till the next issue

Part 14: Insurance

A guarantee to compensate for losses  by an insurance company for the payment of a fee called a premium – all of us know what insurance means – but few of us understand it. Insurance as a product is one of the most abused financial instruments worldwide, especially when sold in combination with other investments.  For the purpose of this discussion right now, we shall limit “insurance” to mean Life Insurance.

In case you die suddenly, you want your family or dependents to be provided for. For this, you make a payment called a premium to an insurance company which is a percentage of the amount insured. The insurance premium is calculated by the insurance company based on your age, state of health, and the term for which you want the coverage.  In case you don’t die, you get nothing (at least in case of pure term insurance). In case you die, your beneficiaries whom you have named in the policy, get the insurance  amount.

So let us look at various aspects of insurance.  To start with, what are the costs typically like, for a pure insurance product?  In India, a good benchmark to assume (and it’s just a rough thumb rule – premiums vary widely across companies) for a pure insurance product (called Term Insurance) is Rs.300 per annum per lakh of coverage for a normal healthy thirty-year old wishing to take a thirty-year policy. That’s roughly 0.3% per annum. The premium will increase if the age is higher, if the term is more, if the policy holder has some existing health problems, if he is a smoker or heavy drinker, if he is in a risky job like a helicopter pilot, or takes part in so-called risky activities like adventure sports regularly.

How much insurance do you need? Assume you are young and have just started working with no dependents. One or both of your parents are still working and they do not depend on you for support.  In that case you do not need any insurance. By the same logic, you should not be taking any insurance policy (or investment-cum-insurance policy) which pays you something on your child’s death. In case you are working and your spouse is not, and you have two growing children, the situation is very different.  You need insurance big time – lots of it! In case you are approaching retirement with most of your financial goals already met due to sticking to boring, conservative, financial plans and savings targets through your working life, why do you need any insurance?  You have already provided for yourself and your dependents, haven’t you?

How much insurance do you need?  This one is complex. Each person’s situation is different.  What experts “recommend” is coverage to the extent of 7 to 10 times your annual income. Let’s do a simple computation – assume you are thirty and your annual income is Rs.5 lakhs. 8 times that is 40 lakhs. 0.3% of that is about Rs.13,500 per annum.  If you have an insurance policy already and are paying a premium somewhere in that range, what is your coverage likely to be? Rs.4 lakhs?  Most likely, yes, since you would have gone in for a ULIP or Pension Plan, Child Plan or some plan that is nothing but investment masquerading as insurance. Of what use is 4 lakhs? Your family can’t even survive for one year on it. Could you have taken a coverage of 40 lakhs under the same ULIP? Yes you could, but your entire annual salary would have to be paid as the annual premium.  Think about that.

You may also wish to check on the insurance coverage provided by your company before you decide on the amount.  A thirty-year old could even follow a strategy of taking separate term policies for, say, Rs.10 lakhs for ten years, Rs.10 lakhs for twenty years, and Rs.10 lakhs for thirty years. This way decreasing insurance needs for a later stage in life as savings increase can be factored in. The same logic can be applied to take coverage against a housing loan – you should take a term policy equal to the loan amount for the period of the loan. There is no restriction on the number of insurance policies you can take.

Finally, how much insurance you actually take is a function of how much you are willing to spend on the premium!
Does it matter which company you take the insurance from?  For all practical purposes, it does not.  All companies have a certain minimum net worth, and follow norms laid down by the Insurance Regulatory and Development Authority of India (IRDA) – hence you can reasonably assume they are likely to be solvent in the long term.  In any case, you need to worry more about that if there is a savings element to your insurance plan which we recommend against. 

How do you choose which company to take the insurance from? That is simple. Go for the lowest quote. Insurance premiums differ widely across companies – one company may be more attractive for a thirty-year old, while another company may have the lowest premiums for a 40-year old.  Each company computes its premiums based on its own actuarial tables and the assumptions are likely to differ.  Before deciding, however, you must check the premiums offered by Aegon Religare.  They offer the lowest premiums for term insurance currently. Their policies are only sold on-line, so you need to visit their website to check on the premiums and to take your policy.

Should you consider any other policy like ULIP, Endowment, Money-back, Guaranteed Plan, Child Policy, Pension Plan, or any other kind of plan?  The short answer is NO. Please restrict yourself to pure Term Insurance. We shall examine the reasons in the next issue. What happens if you already have some insurance policies which are under one of these categories?  In that case, continue paying your premiums and let the policies continue.  You could examine whether it would be more beneficial to surrender them, but that’s a bit complex – I would suggest you should consult a trusted financial advisor who understands these products and is good at spreadsheet modeling!

Should you ask your insurance agent for advice? Again, the answer is NO.  Be very clear what you want before you talk to him and don’t get swayed by any of his arguments.  Better still, don’t engage him in any debate.  We shall see why this is so in the next issue.

In the next installment we shall examine the malpractices that are prevalent in the selling of insurance. It is very important to understand these since so-called insurance products are among the biggest wealth destroyers (for investors, not for the agents) in India today.  Bye till we meet next!