What your insurance agent will never tell you

Data from the Insurance Regulatory and Development Authority of India, the insurance regulator, suggests that 90 per cent of the insurance sold by the private insurance companies during the last financial year (April 2006-March 2007) were Unit-Linked Insurance Plans.

A Ulip has, both, investment and insurance features. A part of the premium is invested and another part goes towards paying the mortality charge for the insurance that an individual taking a Ulip receives. This two-in-one feature is one of the reasons for the popularity of this product.

The other major reason being the high upfront commission offered to insurance advisors selling the product. This leads to insurance advisors pushing Ulips more than other insurance products like term insurance.

Let us say an investor takes a 20-year Ulip. Every year he has to pay a certain premium. In the first year, 15-71 per cent of the premium can be deducted as a premium allocation charge, depending on which insurance company the individual goes to.

What this means is that if an individual decides to pay a premium of Rs 50,000 and the premium allocation charge for the first year is 30 per cent, then only Rs 35,000 will be invested. The remaining Rs 15,000 the insurance company will recover as a premium allocation charge.

The majority of this will be passed onto the insurance agent. When you compare this to the around 2-4 per cent a mutual fund agent makes on selling a new scheme, this is fantastic.

Try buying a simple term insurance policy from an insurance advisor. For those individuals who already have an investment plan in place through mutual funds, it does not make sense to buy a Ulip. But at the same time they do need insurance and term insurance policy which simply insures an individual for a certain amount for the period of the policy, is their best bet.

If the policy holder dies during the period of the policy, his nominee will get the amount for which the individual is insured, if he survives the period, he does not get anything.

Most Indians look at insurance either as a mode of tax saving or investment. Hardly anyone looks at insurance for the sake of insurance. Given this, most do not like to take on a term plan, as they do not get any money if they survive the period of the term plan.

Using this fact as a selling point, an insurance advisor usually tries to dissuade any individual from taking a term insurance policy. The main reason though is that the premiums to be paid in case of term insurance policies tend to be very low.

Also a lot of private insurance companies run contests for their insurance advisors. These contests have expensive cars, foreign trips, etc., as prizes. Insurance advisors are eligible for it only if they manage to generate a certain amount of new business for the company.

If insurance advisors are to get anywhere near having a chance of winning these contests, they can never get there by selling low premium term insurance policies. They have to sell Ulips to be eligible for prizes that these contests offer. Some insurance companies do not consider term insurance policies sold for these contests.

So no insurance advisor likes to sell term plans, which provide only insurance. In the same vein insurance advisors rarely like to sell whole life policies, endowment policies, etc.

When deciding which insurance policy to choose, an individual considers the insurance advisor as an expert and tends to go with what the advisor suggests. But this may not be the correct approach. As Steven D Levitt and Stephen J Dubner write in Freakonomics, A Rogue Economist Explores the Hidden Side of Everything, "But experts are human, and humans respond to incentives. How any given expert treats you, therefore, will depend on how that expert's incentives are set up."

The incentive of the insurance advisor is definitely not in favour of the individual wanting an insurance policy.

Realty MF norms on cards

The guidelines for real estate mutual funds (REMFs), which are being worked out by a panel appointed by the Securities and Exchange Board of India (Sebi), are likely to suggest quarterly disclosure of net asset value (NAV), besides putting an investment ceiling based on individual projects, developers and even locations.

The quarterly disclosure of NAVs is a step-down from the regulator’s earlier stand that REMFs should disclose their NAVs every day.

Sources said the domestic market could see the launch of the first REMF by the end of this calendar as the sub-committee is in the final stages of preparing detailed guidelines for the purpose.

“The guidelines could be out by the end of the third quarter,” a top mutual fund executive said.

He added that even though the launch has been delayed following recent policy changes, all newer issues, including land and property valuation and other regulatory disclosures, will be addressed in the final guidelines.

Last June, the Sebi board had cleared the basic norms for REMFs, stipulating that such funds would initially be close-ended and units compulsorily listed on stock exchanges.

The Sebi committee is also of the view that valuation of properties should be done by qualified experts such as chartered accountants.

Analysts point out that valuation of property will be a key issue before launch of REMFs. “For valuing assets such as property, no value parameter is available. That has to be set up by creating a comprehensive database.

They even have to accommodate recent Sebi guidelines on realty IPOs,” said Ajit Krishanan, partner, Ernst and Young.

The committee is also discussing investment regulations that will spell out per project investment limits, location specific limits and developer specific exposures. These norms are on similar lines as those specified for equity-oriented mutual funds.

Globally, REMFs are known as Real Estate Investment Trusts (REITs). “Globally, REITs are being traded 5 to 10 per cent below their asset value since they are not properly valued,” says Graham F Chase, president of The Royal Institution of Chartered Surveyors (RICS).

This will also be the case in India owing to the illiquid nature and close-ended structure of the funds, a local fund manager said.

Zero tax on income of Rs 11.20 lakh?

There will be zero Income Tax on income of Rs 11.20 lakh (Rs 1.12 million). Impossible? No, it isn't.

One would be forgiven for being sceptical because for the ongoing year (FY 2007-08), the total income exempt from income tax in the hands of a male individual is only Rs 110,000 and that for a woman only Rs 145,000. So how, then, can an income of Rs 11.20 lakh be completely exempt from tax?

You can achieve this by following one of the five golden rules of tax planning, namely:

Spread your income among your family members

This golden rule makes constructive use of the classic British concept of divide and rule. The simple rule is that each family member must have his or her independent source of income so as to legally become an independent taxpayer under the provisions of the Income Tax Law. When the entire income of a family belongs to just one member, the tax liability is very much higher than when the same income is divided among different members of the family.

Thus, the first golden rule of tax planning requires that one develops income tax files for oneself, one's spouse, one's major children, the Hindu Undivided family, and for all other major relatives in the family, including one's parents.

Of course, under the income tax law it is not possible to arbitrarily divide or apportion one's income amongst different members of one's family -- and then pay lower tax in the names of different family members. However, you can achieve this goal by intelligent use of the perfectly legitimate facility of gifts and settlements.

Here is how:

Generally, any gift you receive from various members of your family and specified relatives is not considered your income but a capital receipt. Thus, no income tax is payable on gifts received from relatives, and gifts received from parties other than relatives up to a sum of Rs 50,000 -- and up to any amount at the time of marriage.

Let us consider the example of a small family consists of Mr. A his wife who is a homemaker and not a career person, his major son studying in college, and one major daughter studying in school. They also constitute a Hindu Undivided Family.

The total combined income of all five members of the A-Family, including the HUF, is Rs 11.20 lakh. Every member contributes Rs. 70,000 in the PPF account and has invested Rs. 30,000 in an infrastructure Mutual Funds or company.

Through an intelligent use of gifts and settlements by Mr A to all members of his family, each family member has investments in business, industry, house property, etc., in their own individual names in such a manner that each of the male members and the HUF would have a gross annual income of Rs 210,000 and both the female members have an income of Rs 245,000 each, in all adding up to Rs. 11.20 lakh (Rs 210,000 x 3 + Rs 245,000 x 2)*.

And here is the beauty: this income of Rs 11.20 lakh can be totally tax-free. Here is how:

Section 80C of the Income-tax Act, 1961 provides each individual taxpayer, including an HUF, a deduction of Rs. 100,000 from his/her gross income when investments up to Rs 1 lakh is made in stipulated investment avenues, such as PPF, infrastructure bonds, equity linked savings schemes, life insurance, etc. Thus, all the four family members, and also the HUF, can avail of this deduction under Section 80C to the extent of Rs 100,000 each.

After availing of the deduction of Rs 100,000 each under Section 80C, the taxable incomes of the five taxpayers of the A-Family would be as follows:

Mr A	Rs 110,000
Mr A's son	Rs 110,000
HUF	Rs 110,000
Mrs A	Rs 145,000
Mr A's daughter	Rs 145,000

There, we have it!

The total tax liability of the A-Family is now ZERO, since the income of each taxpaying constituent individual/HUF is below the taxable limit which, as noted earlier is currently Rs 1,10,000 for male and HUF taxpayers, and Rs. 1,45,000 for women tax payers.

It may also be mentioned here that we have not considered the additional tax savings which are possible through a deity Trust, or a trust for an unborn person in the family, which would further increase the zero income tax level income to more than Rs 14 lakh (Rs 1.4 million). In addition, several items of fully exempted income, such as agricultural income, dividend income, income from mutual fund, etc., could be planned for each of the four family members, and also for the HUF, to secure a still higher level of zero income tax for the A-Family.

* Rs 210,000 x 3 (male members) = Rs 630,000
+
Rs 245,000 x 2 (female members) = Rs 490,000

Excerpt from the book:

Tax-Free Incomes & Investments: A-to-Z Tax Guide (A.Y. 2008-09)

By R N Lakhotia

Publisher: Vision Books

How to fund your child's education

Most of us would put our children's education above any other priority in life including, our own retirement. Planning, therefore, is imperative and should begin as early as possible.

With so many products and opportunities available in the market, a whole lot of emotive advertising and innovative products hitting the market every day, it's very easy to get it wrong.

So, let's try to find the best solution.

Step 1: How much would you need and when?

Let's assume you are 30 years and have become a parent recently. Also, assuming that the cost of higher/professional education you desire for your child is about Rs 900,000 at current value.

Since he will enter college at 18, you need to start planning for 18 years later. Since education costs increase faster then inflation, it is safe to assume an increase of 10 per cent per annum. Based on these numbers, you would need Rs 50 lakh (Rs 5 million) after 18 years.

Step 2: Which asset class should I choose - fixed income, real estate or equities?

Let's look at all of them and select the most suited one.

Fixed income investments like public provident fund, National Savings Certificates, fixed deposits, fixed maturity plans etc are the safest form of investment but they give poor returns after adjusting for inflation and taxes.

COST OF EDUCATION
	For investment(Rs)	For Insurance (rs)	Total (Rs)
Diversified Equity Fund	11,146	282	11,428
ICICI Child Plan	11,000	-	11,000
ETF Index Fund � Nifty	9250	282	9532

Real estate could give good returns but it needs to be ruled out because of high initial capital requirement and high entry/exit costs.

This leaves us with equities. It scores over others in more ways than one. Among others, there is scope for diversification, low investment risk if the horizon is long, good inflation adjusted returns and of course, easy liquidity.

Step 3: Now that we have decided on equities, what are our options?

They are:

• Direct investments
• Diversified mutual funds
• Exchange trade funds (the Nifty index fund)
• Education plan through an insurance company

Direct investment in shares could be very dangerous if you are not an expert. The other three are managed by professional money managers. So let us analyse them in detail.

Assume a very safe return of 10 per cent over the next 18 years in all the three options -diversified funds, exchange traded funds as well as child plans.

As far as the cost goes, you can see that the entry load is the maximum in case of the insurance cum investment plan. It is the minimum in case of the ETF tracking the Nifty. Asset management fees are the highest for diversified funds and lowest for the ETF. (See Entry and Management costs)

ENTRY AND MANAGEMENT COSTS
	One time entry load/ allocation charge	Annual Asset Management Fees
Diversified Equity Fund	2.25%	2.00%
ETF Index Fund - Nifty	0.00%	0.50%
"ICICI Child Plan"	"1st yr - 18% 2nd - 5th yr - 5% 6th - 10th year - 2% 11th yr onwards -1%"	1.50%
Asset Management Fees taken above are either quoted in their marketing material or are an approx based on the products available in the market. They may change at the discretion of the companies subject to approval from concerned authorities.

Based on the above charges and expected return of 10 per cent, to reach Rs 50 lakh in 18 years, you would need to invest about Rs 11,150 in a diversified equity fund, or Rs 11,000 in a child plan or Rs 9250 in the ETF.

Besides putting this money aside every month for your child's education, there is another important factor one must not forget. What if something unfortunate was to happen to you tomorrow? Since there won't be anyone else to pay for the education, your investments will not be able to generate the target of Rs 50 lakh.

To guard against this uncertainty you must buy a pure term insurance on your life. The amount of insurance should be adequate enough to generate Rs 50 lakh in 18 years would be Rs 13-14 lakh (rs 1.3-1.4 million), assuming that the entire corpus is invested in the ETF in case of your unfortunate death. A 30-year old can get a term policy from SBI Life Insurance of Rs 14 lakh (Rs 1.4 million) cover for 18 years at just Rs 282 per month!

Since the child plan already has insurance built into it, we have to consider this additional payment for others. So our total outgo per month would be Rs 11,428 for diversified, Rs 11,000 for the child plan and Rs 9532 for the ETF index plan.

As you can see, the ETF index fund with term insurance is the best option. It's about Rs 1500 cheaper. Moreover, you could increase or decrease your investments into ETF any time you like, depending on your situation. At 30, putting even this Rs 9,500 aside per month could be a stretch for many of us.

So you could plough in lower amounts in earlier years and increase them gradually, For example, you could pay Rs 282 per month for insurance and the ETF investments could be:

• Rs 6,000 per month for the first four years
• Rs 8,000 for the next four years
• Rs 11,000 in the next four years and Rs 16,000 in the remaining six years and still reach our goal of Rs 50 lakhs

As we can see that whichever way you may look at it, the ETF combined with the cheapest term insurance on your life, is the best way to plan of one's child's future.

Mutual funds see limited impact from higher tax

Mutual funds expect the increase in dividend distribution tax for money market funds to curtail some inflows, but see it as a small raise that can't diminish their appeal.

"The hike in the dividend distribution tax is the biggest negative in the budget, but it is still better compared to competing products," said Sanjay Prakash, chief executive officer at HSBC Asset Management (India) Pvt Ltd.

Finance Minister Palaniappan Chidambaram said in his budget for fiscal 2007-2008 that he was raising the dividend distribution tax on money market and liquid mutual funds to 25 per cent for all investors.

Currently, such funds attract a tax of 20 per cent for corporates and 12.5 per cent for individuals. Most investors in such funds are companies or treasury organsations with a need to park money for a short term.

The competing products are fixed deposits and shorter maturity products from the banking sector that are taxed at the rate of 30 per cent.

However, "the dividend tax is still lower than the corporate tax," said N Sethuram Iyer, chief investment officer at SBI Funds Management Pvt Ltd. "I don't see a major impact."

Dedicated MFs to help small investor join global takeover

The cap applicable on fund houses for investing in overseas instruments may soon go, provided the investments by retail investors is routed through a dedicated overseas fund.

Fund houses such as Fidelity, Franklin Templeton and Principal that currently allow retail investors to invest abroad are subject to individual ceilings of $150 million across all schemes.

However, mutual funds may now be able to offer investment options to retail investors through a fund dedicated to investing abroad. Such a fund may not be subject to the $150-million ceiling as long as it is strictly restricted to overseas instruments (both debt and equity) only.

While the overall cap of $4 billion for the mutual fund industry will continue, these dedicated funds may not be subject to this annual ceiling. Suppose a mutual fund offers a scheme to its investors wherein 65% of the total assets under management (AUM) under the scheme is invested in domestic equities while 35% of the scheme’s AUM is invested overseas.

Then under the current regulations such a fund will be allowed to invest upto 10% of its total AUM (across all schemes) in overseas equities as on March 31 of the relevant year subject to a maximum of $150 million and within the overall $4-billion ceiling.

However, if the fund house floats a separate dedicated fund, both the restrictions may not apply.
The government is working out guidelines for these dedicated funds as well as for individuals who will invest in these funds.

“The idea is to provide retail investors a platform to utilise their limits for making overseas investments. However, since no ceiling may be prescribed for these dedicated funds, there has to be a reporting mechanism to ensure that individuals are not breaching their limit of $1,00,000 while investing through these fund houses,” an official said.

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