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Session Outline
Effect of inflation on our standard of living. Scope available to protect income streams from inflation. Effect of income tax on residual funds to meet the standard of living. Terminal benefits that are tax free Investment avenues for the terminal benefits. Saving tax through Tax Planning
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We will start with effect of inflation on our standard of living after retirement
The present WPI inflation is 5.7%. Let us assume that it comes down to 5% after the elections. Let us assume you are starting with a pension of Rs. 20000/- per month. i.e. Rs.240000/- per annum. When inflation is 5% per annum, after a period of 12 years, you will need Rs. 480000/- i.e. Rs. 40000/- per month to maintain your present standard of living. The formula for arriving at this number is given in the next slide.
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The formula
Present salary times (1 + assumed inflation rate)^number of years, e.g., 20000*(1.05)^12
After retirement .?
We will discuss how to keep up revenue sources so that a reasonable standard of living is maintained. We need to look at the sources that can keep up with inflation and also look at minimising the outflows in the form of taxes so that money is available to maintain the standard of living we are accustomed.
Provident Fund
Payment from Provident Fund Section 10(12)]: The accumulated balance due and becoming payable to an employee participating in a Recognized Provident Fund is exempt to the extent provided in Rule 8 of Part A of the Fourth Schedule of the Income Tax Act.
Gratuity
As per Section 10(10) of Income Tax Act, any gratuity received to the extent it does not, exceed one- half month' s salary for each year of completed service, calculated on the basis of the average salary for the ten months immediately preceding the month in which any such event occurs, subject to a ceiling of Rs. 10 lacs. ( the limit was Rs. 3.5 lacs till 24.05.2010).
Commutation of pension
As per Section 10(10A) of Income Tax Act, if the employee receives gratuity, the commuted value of 1/3 of the pension is exempt, otherwise, the commuted value of of the pension is exempt.
Leave Encashment
As per Section 10(10AA) of Income Tax Act, if the employee receives leave encashment, the exemption is to be limited to a maximum of 10 months of leave encashment, based on last 10 months average salary. This is further subject to a limit of Rs. 3,00,000/-.
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To minimise tax
In order to minimise tax, we can invest in products wherein either the yearly outflow or the maturity amount is taxfree.
To minimise tax
Equity/equity mutual funds: Long term capital gains (on redemption after a year) from stocks and equity mutual funds are not taxed. However, experts say one must avoid over-exposure to stocks after retirement because they are risky. But given the need for generating returns higher than inflation, stocks may be a part of your portfolio.
Insurance Annuity
The annuity amount is guaranteed for life. Annuity rates are usually benchmarked to medium or longterm government bonds. For example, if you are 60 and want Rs 10,000 every month, you will have to pay the insurer Rs 13 lakh Investment in annuity qualifies for deduction under S 80 CCC of the Income Tax Act
Reverse Mortgage
Reverse mortgage loan: If your retirement corpus is not enough to generate decent regular income to meet your post-retirement expenses, you can fall back on your house. You can take a loan against your home by mortgaging it with a lender (banks/housing finance companies) and receive a lump sum or periodic payments. Since the payments are in the form of a loan, they are exempt from tax
This means capital gains are adjusted for inflation twice, once in the year of investment and then in the year of maturity.
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Duration:Weaknesses
Flat yield curve - same yield, irrespective of maturity or product.
Neglect of non-parallel shifts in yield curve across different maturities - YIELD CURVE RISK. Asset and liability rates, within the same maturities, might not change in the same proportion - BASIS RISK.
For large rate changes, duration underestimates capital gains and overestimates capital losses, since price-yield relationship becomes nonlinear CONVEXITY
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