How to save some TAX

How to calculate HRA for Tax Exemption

Most of us pay more tax by neglecting to know about House Rent Allowance (HRA) component in our payslip.

What is HRA?

HRA is house rent allowance offered by employers to all its employees. HRA is exempted from taxable income under Section 10(13A) of the Income Tax Act.
This reduces the tax paid by an employee.


How HRA is calculated?

The HRA calculated by the employer is the minimum of the following three amount.

1. Actual HRA given by the employer as mentioned in the payslip.
2. Actual rent paid by employee minus(-) 10% of his/her basic salary
3. 50% of basic salary in metro cities (Delhi, Mumbai, Chennai, Calcutta) or 40% of basic salary in other cities. (Yes, Hyderabad and Bangalore do not come in metro cities category, Very Strange !!! )


Lets take an example.

Ram lives in a house in Hyderabad and pays a rent of 7,000. The HRA offered by his employee is 6,000/month and his basic salary is 20,000/month. Let us calculate the three amount stated above

1. HRA offered = 6,000
2. Rent - 10% of basic = 7,000 - 10% of 20,000 = 5,000
3. 40% of basic salary = 40% of 20,000 = 8,000

Hence minimum of the three Rs 5,000 is taken as HRA and 12 * 5,000 = 60,000 is exempted from tax for the current financial year.

Note : You have to pay monthly rent receipts to your employer and you can not have short routes in stating wrong rents paid by you.

Those who are staying in with their parents (Home in the name of Father) can also claim HRA by submitting Rent Receipts, Conditions to be follow :-
1) Rent receipt paid to the father.
1) Father is not dependent on you.
2) Father has to show Income from property while filing his Income tax returns.
3) If Father income is less (at least on Form 16 ) then it is beneficial to claim HRA,
as he is in lower tax bracket than you may be.

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How to save tax by showing Medical Expenses

If an employee receives money for his medical treatment or the treatment of any member of his family then a sum up to Rs 15,000 p.a. is tax exempt. This exemption is enjoyed by the employee only if the expenditure is actually incurred and is supported by supporting bills. Even amount spent by you in the local medical shop on purchase of medicines and supported by a bill is eligible for exemption up to Rs 15,000.

Any premium which is paid for medical insurance that has been taken on the health of the assessee, his spouse, dependent parents or dependent children, is allowed as a deduction, subject to a ceiling of Rs 10,000.

Additional deduction of Rs 15,000 under Section 80D is allowed to an individual who pays medical insurance premium for his/ her "Senior Citizens"parents/dependents.
The deduction is available only if the premium is paid by cheque (Don't know why this clause is added).

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Tax exemption allowed on LTA

The LTA amount is received from the employer towards a journey within India. LTA is eligible for deduction under the Income Tax Act subject to compliance with specified conditions.

Conditions :-

• It should be received from the employer for himself and his family.
• He should be proceeding on leave to travel to any place within India only.
• The exemption is available to an individual for two journeys in a block of four calendar years.
• The current block is calendar years (January to December) 2006 to 2009.
• In order to claim the exemption, he must produce original proofs for expenses, Original tickets.
• The tax benefit is for actual fare (Journey) only.
• Hotel, food, sight seeing, local conveyance etc are NOT allowed in exemption.
• For the purposes of this exemption, 'family' means the spouse and children of the individual, and parents, brothers and sisters who are mainly dependent on the individual.
• In case the journey is by air, an amount not exceeding the economy fare of the national carrier by the shortest route to the place of destination is taken.
• In case the place of origin of journey and destination are connected by rail, and the journey is by any other mode of transport other than by air, an amount not exceeding the air conditioned first class rail fare by the shortest route to the place of destination is taken.
• The exemption is available for a maximum of two children of an individual.
• The exemption is available for the farthest place by shortest route when a circular journey is undertaken.
  

The amount exempted under Section 10 will be the amount actually incurred on the travel.


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Interest Free Loan from Your Employer is not that "FREE"

Suppose you take a loan of Rs 60,000 for one year from your employer. Your employer will deduct Rs 60,000/12 months = Rs 5,000 per month from your salary. The amount you have paid back to your employer at the end of one year is Rs 60,000, which means that you have paid zero interest. In effect, it’s a free loan.

Now, no loan in this world comes for free.

Therefore, a component called “Notional Interest” is added to your taxable income under a section called "perquisites". Notional interest is the interest that you would have paid had you taken a loan from a commercial bank.

For simplicity, let us assume a notional rate of interest at 10% (simple interest). An amount = Rs 60,000 * 10% = Rs 6,000 gets added to your taxable income as a perquisite. You therefore have to pay tax on this “notional interest” component of Rs 6,000.

The tax payable of course depends on which tax bracket is applicable to you.

So my Friend their are no free lunches in this world.

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Have you ever looked close at the statement of tax generated each month (along with your salary slip) by your employer? Do you understand where your money is going? If no, it’s high time for you to do it NOW.

Life Insurance Revisited

One of my good friend had a small argument with me, that she would not "invest" in Term Plan of Insurance, because she will not get any "returns" out of it. I believe "investing" in a term plan looked a very unprofitable thing to her as she never gets back the money she paid as "premiums" , if she survives.

Endowment plans looked nice to her, because they provide money if you are dead and even if you survive. You get back money as the prize for not dying !!!.

With respect to Term insurance , she understood the fact that her family will get the money from insurance company in case of her death, but she was concentrating on the fact that she would not get back anything if she survives. What is the return in that case? Nothing !!! , and looked like some one is fooling you with a product called "Term Insurance" , where you are "investing" premiums to get nothing at the end.

Let me now tell why this happens and some give you some insight on this matter.

I have already talked earlier in my last post "Life Insurance and how to go about it" , about Term Insurance . Let me now take more deep dive into it and talk about the reasoning part.

I will first talk about fundamentals of Insurance and then talk about Endowment Policies and why are they popular, and what people don't realize about them. And I will try to show how Term insurance is the right thing for most of the people.


Basics of Life Insurance

What happens in a average family : There is someone who earns and his family comprises of wife, kids and parents. If not all there is a subset of these family members. The head of the family earns and his family lives happily. All the expenses are met from the earnings of this main member, most of the time the husband. Now consider this person dies in an accident or for that matter because of any event. What happens? What happens to his family members other than the psychological trauma. If they don't have money to take care for them selves, either some one from family have to take up the job and start working which may not be possible for them, or They have to decrease their standard of life to maintain the expenses. They are now totally unsecured from future's point of view. In short "Unka puri tarah se band baj gaya hain mamu". I gave this detailed explanation for the circumstances because I wanted you to understand how bad can happen and proper measures must be taken care for this.

What is the Solution?

Adequate Coverage !!! , this cant be compromised at any cost whatsoever... You must have a backup plan which can give your family the same kind of income which confirms that they are not short of money in case the main earner is gone to meet GOD. If there are some debts like Home Loan, or any other tasks which need money apart from regular income, the cover must be good enough to cover that too.

For example : Robert has a family expenses of 25,000 per month and there is a Home loan of Rs 25 Lacs to be paid within 10 yrs. He is 27 yrs old. He has a wife, 2 kids and parents. All of them are dependent on him financially (5 dependents). He has investments of 5 lacs (He is software engineer so could have done this investment). In case he dies (actually went to met GOD), who will take care of Home loan, From where will his family get enough money to live life comfortably.They need 25k * 12 = 3 Lacs per year (As per Roberts Current earnings). They can get this income per month if they have 35-40 Lacs of money in bank, they will get Rs 25,000 per month as interest which they can use. Considering inflation it will not be enough after some years , but lets keep it aside it now for this example.Add home loan of 25 Lacs to this 40 Lacs and what we come to know is that this family must be covered with minimum Rs 65 Lacs. Rs 75-80 Lacs is a decent cover for this family.
Now if he takes a cover of 80 Lacs for his family, from that day he can happily live with all his life without any tension ( Jeete Reho !!!). He will be attain peace of mind and not be worried for it. He must get a lot of internal peace because his Family is protected with a good enough cover to take care for them . And this is what you get in "Return" from Insurance. No monetary return can give you more satisfaction than peace of mind.

So before doing anything else, his first step is to give adequate cover to his family and that's the most important responsibility for him as a Husband, Father, Son . He must understand that this is not an investment for monetary benefit later in his life, but its for his family happiness and future.

One point to remember and not forget is that this is the minimum cover required for family and anything less than this will be taking risk with family future.


Endowment or Money back Policies

Lets discuss the problems with these plans with respect to the above example.

High Premium : For an 80 lacs cover for say 30 yrs , the premium payable will be At least 2-2.5 lacs/year (this is a conservative figure) . So now premium so high is not possible for anyone like Robert, so what they do? They go with a kind of cover for which they can pay premium easily. He may go for a cover of 5 lacs, 10 lacs or maximum 20 lacs. And guess who suffers in case of his death : HIS LOVED ONE's.

It might also happen that they are compromising on a lot of small things which are important at that moment in time, like buying a bike for son, which they can't buy because of the insurance premium they have to pay, or some vacation they could have gone to with family, but compromise on that because of premium payments.

Money back at the end of the maturity is like a penny after so many years :

This is some thing most of the people overlook. They just see the numbers 5 lacs, 10 lacs or 20 lacs . And at the time of taking Insurance it looks good figure to them because they see numbers, they don't see its value after many years. They don't consider Inflation into account. In case of above example, if Robert takes a cover of 15 lacs by money back policy, what happens if he survives the tenure. He gets 15 lacs at the end, Great Money after 30 yrs, Not at all !!!

Lets see how great this money is? His monthly expenses will grow from 25,000 per month to 1.5 lacs per month (considering inflation of 6%) . Now this money will help him survive for not more than 10 months... For so many years he pays high premium each year, just to get back money to cover his 10 months monthly expenses ? What the hell (Prize of Survival - 10 months security) !!!

Under Insurance : Because of the fact that people want money back on survival and because of high premium, people end up taking policy for which they have to pay premium under there budget, which means less cover.
Without realizing the fact that they are highly under insured, the reason for this is that they see Insurance as investment product and not a protection cover for there family. When they die, there family get the money from Insurance company, but most of the time its not enough for them and it erodes very soon.


Term Insurance Policies

Lets discuss the features of Term Policies with respect to above example.

Cheap Premium : The premium is very low for Term insurance Policies. For above example, the yearly premium for Rs 75 lacs cover for 25 yrs is just Rs 20,000 yearly or just 1,600 per month !!! This is in any way affordable for most of the people. Its providing the fundamental requirement of Good cover and low premium and if you think of returns, good cover and low premium can themselves be seen as good enough return. You family protection at low cost is the return you get.

Opportunity to invest rest of the money in High return Investments :

With term Insurance you save a lot of money in premium and now you can invest this money as per your wish in high return instruments, anyways in Endowment policies you put money for long term and you get it after so long time. So you can now always put your saved money in things which are long term investment products and give great returns.

One of those things is Equity Diversified Mutual funds and Direct Equity (depending on persons ability and interest). In long term Equity Diversified gives fabulous returns (15-20 yrs) and the risk is minimized because of long term. And if you consider India growth story, it looks great in long term, hence Equities for long term is the most obvious choice. They will give you return of 15%+ CAGR. (15-20 yrs)

Also it will be flexible, you can not invest for a year or two, if you want to use the money for your family vacation or some important event.

Conclusion :

Insurance is not an investment product, its a Protection instrument for your Family or any one your want to cover. There are other products for your investments. Dont ever go for Endowment Policies.

AVOID Endowment Policies

Now we will look at the most known and most invested scheme by all of you - Life Insurance Policies.


A look at the Endowment Policy (LIC Policies like Jeevan Anand, Jeevan Astha, Jeevan Surabhi)

An Endowment policy would look like this for a 25 yrs old

Tenure : 30 yrs
Yearly premium : 31,000
Sum Assured : 10 Lacs
Maturity amount : 23.1 Lacs lacs ( this you get when you survive full tenure , It includes the sum insured + Bonus accrued)

This data is from website of an Insurance company.

Q . How much money to be paid every year? How much will the person get in case of Death or Survival ? What are the Risk factors ?

Ans :
Tenure : 30 yrs
Money outgoing : Yearly 31,000 / year
Money received Incase of Death : 10,00,000 (10 Lacs)
Money received Incase of Survival : 23,10,000 (23 Lacs)
Risk : Virtually no risk (The only risk is when the Insurance company goes bankrupt which is happening nowadays in US)

What is the interest earned on this investment ? 31,000 per year for 30 years becomes 23,10,000

Annuity formula is :

Maturity value = Amount paid per year * [ {(1+r)^n - 1}/r ] * (1+r)
Here n = 30 years
and r = rate of interest earned

Putting all these values

23,10,000 = 31,000 * [{(1+r)^30 -1}/r] * (1+r)

The value of r which satisfies this equation is 5.4 . Which means that the interest earned by the investment in Endowment policy is mere 5.4%, which is truly pathetic by any standards at least in India. There is no investment product which is known to pay so badly .
Even the safest SBI Fixed Deposits are also paying more than 9% returns.

The reason why people feel that endowment policy are so good is that they also get insurance cover ( which is virtually useless because its so less that it does not even cover the financial dependents to even a fraction of what they need in reality).

So can we mix Insurance + Investments product which can be supremely better than Endowment policies and still cost the same( or even less) .

Now let us see that by spending same amount Rs 30,000 (1,000 less than the endowment policy) every year for 30 yrs, can one achieve better than this ?


Yes we can definitely achieve better than this and we will do it !!!


Option 1. For Safe Investor (Let us first see a almost 100% safe way to do this)

Premium for Term Insurance of 30 Lacs for 30 yrs: Rs 6,000

Investment of 24k in PPF for 30 yrs : 30 Lacs (this is assured returns, as its invested in Govt backed PPF, which gives 8% post tax return)

Amount invested : 30,000 per year for 30 years (same as Endowment policy) (Actually Rs 1000 less)
Amount received on Death : 30 Lacs + investments done in PPF
Amount received without Death : 30 Lacs (investments)


Option 2. For Aggressive Investor ( A person who can take more risk that the former one)

Term Insurance of 70 Lacs for 30 yrs : 14,157 (Since he is more aggressive, I will consider his insurance to be more - 70 Lacs)
Investment of remaining Rs 17,843 ( 30000 - 14157) in ELSS for 30 yrs assuming 15% CAGR : 92 Lacs

Amount invested : 30,000 per year for 30 years (same as Endowment policy) (Actually Rs 1000 less)
Amount received on death : 80 Lacs + investments done in ELSS
Amount received without Death : 92 Lacs (investments)

Equity investments for long term (20-30 years) are almost risk free.

So , we can see here than in any case term insurance + Mutual Fund (PPF) is supremely better than Endowment policies.


Conclusion :
Insurance is not an investment product , its a Protection instrument for your Family or any one your want to cover. There are other products for your investments. Dont ever go for Endowment Policies.