Do you know the rule of 72?:: Business Line

The increasing culture of consumerism makes savings rather difficult for everyone. This culture has made it even tougher to encourage young working professionals to start their retirement savings early in their career. In this article, applying behavioural psychology, we discuss measures that can enable you to start your retirement savings early.

There are two reasons why you should save early for your retirement. First, consider the rule of 72. The number of years it takes to double your investment is approximately 72 divided by the returns on your investment. That is, if you expect to earn 10 per cent on your total portfolio investments, you may be able to double your portfolio value in 7.2 years. So, longer your investment horizon, higher the benefits that you can expect to gain from compounding of returns.

For example, if your investment horizon is 15 years, your initial portfolio value may increase 4 times — double in the first 7.2 years and then again in the next 7.2 years. If your investment horizon is 30 years, you can expect to earn 16 times the initial portfolio value. Of course, the power of compounding works in your favour only if your investments are in interest-bearing instruments such as fixed-deposits. This is because, unlike equity, fixed-deposits generate only positive returns, as nominal interest rate cannot be negative. It is sufficient to know that the power of compounding does more harm than good when you have equity investments.

This brings us to the second reason why you should start your retirement savings early. Because you will necessarily have equity investments and because such investments may have negative returns, compounding could have adverse effects on your portfolio. In such circumstances, a longer investment horizon offers you a greater chance of recovering losses on your investments before you retire. Despite the benefits, few young professionals start early. Why?

CONSUMPTION VS SAVINGS

You can benefit from current consumption today whereas you reap the benefits of saving only in the future. You, therefore, choose to consume more today at the expense of not saving early for your retirement. Behavioural psychologists call this tendency to prefer the present and discount the future as present bias.

How can you moderate present bias? We apply two concepts from behavioural psychology to help you moderate present bias. One is procrastination and the other, priming. Consider procrastination. We typically prefer to make right choices in the future, not today. That is why dieting is easy to practice in the future, not today, as is savings. Taking cue from this behaviour, we want you to commit today 20 per cent of your future incremental income every year to retirement savings. So, if your monthly salary were to increase by Rs 10,000, you should set aside Rs 2,000 towards your retirement savings. Importantly, you should implement a process today to automatically debit the amount when you receive the salary increase next year.

Next, consider priming, a subtle presentation of an idea that can impact your behaviour. You can impact your savings behaviour using visuals. That is, instead of saving for an abstract goal- accumulating, say, Rs 25 crore for retirement — work towards specific objectives such as saving for an Alaskan cruise, post-retirement. Research has shown that you can be nudged to save more if you can visualise your goals. Further, have a simulated image of your “older” self in your computer desktop to help you relate to your old age.

There are two reasons why you could fail to achieve your investment objectives. One, you do not save enough. And two, your investments generate lower-than-expected returns. You can control your savings, not returns on your investments. So, improve your chances of achieving your investment objectives through disciplined savings. Start saving today for retirement.

Taxing buybacks:: Business Line

What would have been a gain to the shareholder would now be subject to tax in the hands of the company.

Dividends are taxed and so are capital gains. But here’s a new one. The Finance Bill 2013 has seen the introduction of a tax on buyback offers where sums paid by the company to the shareholder, over and above the issue price of the shares, are to be taxed.

WHY BUYBACK

A company may choose to buy back its own shares for various reasons. These could include attaining a target capital structure, returning value to shareholders, facilitating exit to shareholders or even stabilising the share price.

The buyback of shares has however been at the receiving end of a lot of flak too. Where companies have overseas shareholders, the strategy has been maligned as a tax avoidance scheme to repatriate profits outside India without suffering tax.

Under the new provisions, the consideration paid by the company for the buy-back of shares, which is in excess of the amount received by the company during issue of shares, will be charged to tax at a flat 20 per cent (plus applicable surcharge and cess). This tax will be levied at the hands of the company making the buyback.

This would essentially mean that what would have normally been a gain in the hands of the shareholder would now be subject to tax in the hands of the company. This tax is envisaged to be a final levy, with no further tax liability (capital gains liability) in the hands of the shareholders. Interestingly, consideration from buyback was hitherto regarded as capital gains under the Act and the shareholder taxed accordingly (subject to tax treaty benefits for non-resident shareholders). But it would now be regarded as akin to dividends.

ARBITRARY JUDGMENT

This perhaps takes a leaf out of the Otis case, where the Authority for Advance Ruling (AAR), adjudicating in favour of the Revenue held that the transaction of buyback was a ‘colourable transaction’, and characterised a buyback as a means to distribute dividends, rather than return of capital to shareholders.

The AAR judgment was widely trounced as arbitrary. There was slight relief when the Shome committee in its report expressed the opinion that buybacks should not be regarded as ‘colourable transaction’ warranting the attraction of GAAR.

However, the Government, though it has ostensibly accepted large portions of the Shome Committee report, seems to have held on to its own opinion on the ‘colourability’ of buyback transactions. The new buyback distribution tax clause could hence appear to have a dual impact, resulting in a change in income characterisation as well as tax liability.

Under the capital gains characterisation, a non-resident shareholder in Singapore or Mauritius, does not pay any tax since India’s treaties with these countries allows taxing rights on capital gains to the country of residence.

Given that these countries would characterise the income as tax exempt, no credit on the new tax would be available under the respective treaties, thereby increasing the cost of investment.

These new proposals for taxation of capital transactions give rise to questions on equity of the principles of taxation being followed in India.

An entrepreneur could be taxed for making investments as well as exiting the investments. Though this may have been a ruse to garner more revenues, what if companies choose to forego the buyback route completely? Other repatriation strategies, including dividend distribution, may be preferred to take advantage of the tax arbitrage. This leaves us with the biggest question — contrary to revenue authorities’ expectations, would both the share premium tax and buyback tax be reduced to sections in the Act which never get applied? We will have to wait and see!

Good diversifier:: Business Line

5 questions on health insurance:: Business Line

Several insurers today offer covers which include women-specific illnesses such as cancers of the reproductive system, pregnancy-related complications and so on.

The days of men being the only earning member of a family are long gone. Today, not only do women contribute to household income, in some cases they are also the sole earning member.

Even if a woman is a homemaker, her falling ill can really upset the family’s finances. Thus, it is important for every woman to have her own health insurance plan.

Every woman should ask 5 key questions before buying health insurance for herself.

How much cover do I need?

The most important question is regarding how much insurance you need. This decision should be based on your age, the number of dependents you may be supporting, as well as the cost of medical care in the city you live in. With soaring medical costs, it is advisable to pick a cover that adequately supports these requirements. Furthermore, it is advisable to increase the sum insured by 10-15 per cent every year to match the medical inflation.

What should the policy cover be?

While health insurance will usually cover your hospitalisation expenses, you should look into a plan which also covers certain illnesses specific to you. Several insurers today offer covers which include women-specific illnesses such as cancers of the reproductive system, pregnancy-related complications and so on.

Covers for maternity and new born babies are also becoming common. As maternity benefits are often not covered by employers, it is a good idea to opt for such a plan.

It will also help in case you decide to quit or change jobs in course of time. It may be necessary to hold both a health cover and a critical illness cover. To illustrate, a health insurance plan from Bajaj Allianz for a 30-year-old woman would cost Rs 3,283 a year for a sum insured of Rs 2 lakh, and a woman-specific critical illness plan would come up to Rs 1,719 for the same sum insured.

Does it have any women-specific benefits?

In addition to covering specific ailments, some products also offer additional customised benefits for women. These include a loss of job bonus, as well as children’s education bonus. Some insurers offer up to Rs 25,000 for the education of one or more children. This amount can act as relief for their education in the future, especially in times of break or loss in income of a working woman.

In case the insured losses her job within a few months of being diagnosed with a critical illness, she would also be eligible for a certain amount towards this loss of employment.

However, any voluntary resignation from a job is usually not covered under an insurance policy of this type.

Do I get any tax benefits?

As a working woman, tax saving helps pep up your disposable income. According to current tax laws, the premium paid towards health insurance is eligible for tax deductions under the section 80D of the Income Tax Act.

How do I select my insurer?

While choosing your insurer, there are a few key aspects that you may want to consider.

Network of hospitals: Consider the network of hospitals of the insurer as this would enable you to get the best treatment in your city, and perhaps close to your residence. Facility of cashless claims offered at network hospitals is an advantage that can lead to savings in many forms.

Claim settlement services and financial standing: Opting for an insurer with an in-house claim settlement team may help secure the benefits more easily. Lastly, you may also want to consider the financial standing of the insurer and their ability to honour claims.

Although the insurance industry is yet to come up with differential premiums and product features for women, it may soon become the norm.

Women are considered to be less susceptible to heart and other ailments which may work in their favour, especially in terms of a health insurance plan.