Problems with the NPS (National Pension System), India

The Indian Govt launched the National Pension System with high hopes and much fanfare. Unfortunately, despite several positives, it has not taken off as expected. Some blame it on the lack of incentive for intermediaries (agents, financial institutions etc) to sell the scheme. While true to a certain extent, why do you really need an incentive for higher offtake if it was so good for the public? True that agents will sell it more if they get better commissions, but at the same time it is also true that many (if not most) agents will mis-sell any product which gives them higher commissions, whether good for the investor or not.

There are several other pension products in India and none of them seem to be doing too well. May be they are doing a bit better than NPS due to the mis-selling being done by agents. Here I look at the most basic flaw or shortcoming of pension products in India including NPS.


"On attaining the Normal Retirement Age (NRA) of 60 years – You will be required to compulsorily
annuitize at least 40% of your pension wealth and the remaining 60% can be withdrawn as a lump
sum or in a phased manner; in case, you opt for a phased withdrawal"


Not just that, "Withdraw any time before 60 years of age– In such case, you will have to compulsorily annuitize 80% of your accumulated pension wealth"

Basically what Govt is telling us is that they kind of control our choice on what we want to do with our money on retirement. There are 2 basic flaws as I see it:

1. If a person is sensible enough to invest in a pension scheme, he would be sensible enough to know what to do with the money he receives on retirement. Govt. really has no business dictating what to do with the our hard earned money on which we have already paid tax. It's high time Govt start treating citizens of the country as adults. If we are mature enough to elect Govt to take decisions for the country, we are mature enough to take decisions for ourselves.

2. We may still be able to tolerate Govt limiting our options on what to do with our money if Govt provided us any sensible options. The only option Govt provides is to take Annuity. We don't know what kind of annuity options will be available to us when we retire. But at least today the annuity options available in market are probably the worst investment options.

Let's take a look at the annuity options in market today. There are 2 broad kinds of annuities available in the market today:
a) Annuity without the return of capital
With this, one receives the pension till one is alive. After that, the money is gone!! Stupid enough. It might work well in western societies where most people live their lives independently of their children. This probably won't work well in India, where people expect that their children benefit out of their savings when they are no longer there.
E.g. For a corpus of Rs 10,00,000 (i.e. 10 lakh), the pension may be around Rs 7500-8000 per month till the person lives. Once the person dies, the amount of 10 lakh is gone!! If a person dies 5 years after retirement, he/his heirs would have effectively received only Rs 4,50,000 out of the Rs 10,00,000 he invested.

b) Annuity with the return of capital
This probably is more suited to Indian needs as such plans return your original capital to the legal heir or the nominee. But there is a catch - the annuity amount (pension) given is very pathetic. E.g. For a corpus of Rs 10,00,000 (i.e. 10 lakh), the pension may be around Rs 6000-6500 per month. So, even though it returns the capital, it provides substantially lower returns than the annuity with return of capital.

Then there are other variations of the above 2 basic kinds of annuities, but the common theme across all of those is the meager returns they offer.

Compare the returns from annuities in market today with the Monthly income plans (MIP) available in the market today. With a lump sum of Rs 10,00,000, you can get a monthly income of around Rs 7500 per month and return of capital at the end of the tenure which is typically 5 years. Post office has some of the best schemes for senior citizens.

Note that the examples used above are based on current rates in the market. The pension/monthly income offered by such schemes changes with interest rates in the market, this is similar to how rates on fixed deposits change with interest rates in the market. Once you book a FD, the rate is fixed for the tenure of the FD. Same with annuities or MIPs.

One risk with monthly income plans is that when you get back your money after the tenure, you need to invest it again at that time to get regular income. And the interest rates at that time may not be the same. So you do have a risk with MIPs which is not there with annuities. As with annuities the rate is fixed (the pension amount if fixed) when you buy the annuity. But that has an even bigger catch:

The same interest rate risk is present in a much bigger way with NPS. Who knows what the interest rates will be like when you retire? You will be forced to buy annuity at that point of time even though it may not be a good time to buy annuity, if the prevailing interest rates are low.

Instead if Govt gives us our money back, we could choose whether to buy an annuity or MIP or some other investment. Or if we want to defer buying an annuity for some time.

Bank FD or Infrastructure bonds

Some people ask the question whether to go for Bank FD or Infrastructure bonds. Really there is no need for comparison of Bank FD with Infrastructure bonds.

The reason is simple: The amount of investment which qualifies for Sec 80 rebate is normally Rs 1,00,000 (includes PF, PPF, ELSS i.e. tax saving mutual fund, NSC, 5 year bank FD etc). If you plan to invest only upto Rs 1,00,000, just go for the investment which gives you better return. So in that case, if SBI FD is offering 9.25%, it is better than an infrastructure bond offering 8.7%. Both have a lock in period of 5 years. The interest from both is taxable. Whichever offers better rate of interest, go for it. The bank FD is compounded quarterly which is an additional benefit.

The only advantage infrastructure bonds have over bank FDs is when you plan to invest more than Rs. 1,00,000 in the financial year. The infrastructure bonds provide you tax saving on Rs 20,000 over and above the 1,00,000 limit. So, if you make a total investment of Rs 1,20,000 including at least 20,000 in infrastructure bonds, you will get tax benefit on complete 1,20,000. But if your investments do not include infrastructure bonds, you will get tax rebate only on 1,00,000.

Example 1:
Ram makes the following investments:
1. PF  - Rs 40,000 (Employee contribution only)
2. PPF - Rs 20,000
3. Tax saving mutual fund - Rs 40,000
4. NSC - Rs 20,000
Total = Rs 1,20,000.
However, all these instruments come under the 1,00,000 limit, so Ram will get tax benefit on Rs 1,00,000 under section 80.

Example 2:
Shyam makes the following investments:
1. PF  - Rs 40,000 (Employee contribution only)
2. PPF - Rs 20,000
3. Tax saving mutual fund - Rs 20,000
4. 5 year bank FD - Rs 30,000
5. Infrastructure bonds - Rs 20,000
Total = Rs 1,30,000.
The first 4 instruments come under the 1,00,000 limit, so Shyam will get tax benefit on Rs 1,00,000 for first 4 investments + Rs 20,000 benefit for infrastructure bonds. So he will get tax benefit on a total of Rs 1,20,000.

Another point to note is that the maximum benefit above 1,00,000 with infrastructure bonds can be only upto Rs 20,000. So if you have already invested 1,00,000 in other instruments and your purpose is only tax-saving, then you should only invest a maximum of Rs 20,000 in infrastructure bonds.

Should you invest in Tax-saving Infrastructure bonds

First of all, a word of caution about the "realized" return the companies or agents tell you. Most of them exaggerate the returns because they assume that you fall in 30% tax bracket when you are investing and you fall in 0% tax bracket when you receive the interest and so they don't factor in the tax on annual interest received. Obviously if you are in 30% tax bracket this year, it is highly unlikely that you will be in 0% tax bracket next year.

Let's look at the real "realized" returns. We will consider that if you are in 10% income tax bracket today, you will be in the same tax bracket in the coming years. The real returns are higher than the interest rates because you save tax under section 80 CCF on investments upto Rs 20,000 in infrastructure bonds.

Here is a list of some of the current infrastructure bonds in market (2012 Infrastructure bonds), which can help you save tax for the current FY 2011-12. (Last date mentioned are for current tranches)

http://www.idfc.com/infrastructure_bond/scheme_features.htm (Last date: Feb 25, 2012)

http://www.ltinfrabond.com/index.aspx (Last date: Feb 11, 2012)

http://recindia.nic.in/infra.html (Last date: Feb 10, 2012)

Let's look at the real returns from the IDFC bonds.

This is the return table IDFC has provided (for investments upto Rs 20,000):

This is the real "realized" return (for investments upto Rs 20,000):

As we can see, the returns are not as high as claimed by IDFC and some of the advisors/agents. However, the real returns are still good compared to several other investment options.

Couple of points to note are:

1. infrastructure bonds provide the tax exemption over and above the 1 lakh limit which other instruments like PF, PPF, NSC etc provide in Sec 80.

2. It is better to use the buyback option provided at the end of 5 years compared to holding the bonds till maturity.

Though we took the specific example of IDFC bonds, but the same is applicable for infrastructure bonds by L&T and REC as well.

Can police sue a thief for not informing about theft?

The question is very simple - can police sue a thief saying that the thief should have informed us before commiting the theft. Since the thief did not inform us when and in what way he is going to do the theft, we were not able to catch him!!

I won't be surprised if this sounds stupid to say the least. But this is what the supposedly educated people do:
http://economictimes.indiatimes.com/news/news-by-industry/services/consultancy-/-audit/price-waterhouse-files-suit-against-ramalinga-raju/articleshow/11436145.cms

Yes, the auditor PriceWaterHouseCoopers who is supposed to find any wrong-doings and audit the accounts is suing Ramalinga Raju, the (erstwhile) CEO of Satyam for hiding the wrong-doings from the auditors and mis-representing documents. Well, isn't that the reason what the auditors are appointed for - to catch such misdeeds. What do the auditors get paid for - to accept whatever management says?

Why would a globally renowned auditor like PWC not independently verify things like bank balance and rely on the forged documents given by the management? Is it to say that we catch only one kind of frauds and not others? The auditors are required and entrusted to catch any form of fraud - whether accounting scandals, mis-reporting, forgery of accounts, whatever. In essence everthing, that's why they should to be able to state that the financial statements published by the company are true statement of accounts.

There are opinions which say that the auditors were hand-in-glove with the Satyam management in the fraud. Well, no one knows. Either they were, or they were incompetent.

It would be interesting to see the court opinion on this kind of lawsuits.

Increase in EMI or increase in tenure or part prepayment

With day by day increasing interest rates in India and in some other countries as well, many home loan borrowers are wondering which is the best option for them?
1. Increase in EMI
2. Increase in tenure
3. Part-prepayment to keep the same EMI and tenure.

Let's take an example. The borrower has a home loan of 30 lakhs (30,00,000) for a duration of 20 years. Let's say the rate of interest was 9% and so the EMI was 27,000.

Scneario: Rate of interest increases from 9% to 10%

Option 1: Increase the EMI to 28,980 and keep the same tenure of 20 months
Option 2: Increase the tenure to 26 years, 2 months and keep the same EMI
Option 3: Make a part-prepayment of 2,05,000 and keep the same EMI of 27,000 & the same tenure of 20 years.

Which one is better? Let's look at all the 3 options. Let's look at what would be the total outgo in complete repayment of the loan in all the 3 cases.

Before interest rate increase (rate at 9%): Principal = 30,00,000. Interest = 34,75,000. Total outgo = 64,75,000.
Option 1 (Increase EMI): Principal = 30,00,000. Interest = 39,33,000. Total outgo = 69,33,000.
Option 2 (Increase tenure): Principal = 30,00,000. Interest = 54,67,000. Total outgo = 84,67,000.
Option 3 (Part prepayment): Principal = 30,00,000 (including part prepayment). Interest = 36,76,000. Total outgo = 66,76,000.

As you may notice, the principal amount one repays remains the same, as that is the loan one has taken. The difference is in the interest.....and what a difference!! Another thing to notice is that the total outgo in all the three options is higher than the current situation - this is obviously because the rate has increased from 9% to 10%. So the borrower is worse off than before. But by how much is the question? How much worse off the borrower gets depends on what option the borrower chooses. Let's see.

As is obvious, the best option is to go for partial prepayment to keep the EMI and tenure the same, but again it requires a lumpsum payment which may not be possible due to financial constraints.

The next best option is to pay higher EMI, again subject to whether one is able to afford the increase in EMI.

The last and the worst option for the borrower is increase in the tenure of the loan. No wonder, banks increase the tenure of the loan by default unless you specifically ask them to increase the EMI or opt for part prepayment. The banks will opt for increase in EMI or part-prepayment only if the tenure is getting too long and is not allowed by their policy. The bank's choice is in the bank's best interest and not yours.

So, visit the bank. And ask them for other options. Ask what would be the increased EMI if you want to keep the same tenure? Or how much prepayment you can make to keep the same EMI and same tenure. Even if the bank charges a 2% penalty on partial prepayment, it may be worth it. Give it a thought!! Visit the bank and get to know your options!!

Note: The calculations are rounded off and may be off by a bit (a couple of thousands). But they are accurate enough to make the right point! :-)

Effect of interest rate increase on loan EMI

RBI has increased the repo and reverse repo rates several times in the past one year and the indian banks and NBFCs have been quick in passing on the higher interest rates to their existing loan customers. With recent interest rate increases, one wonders what is the impact on the EMIs (the monthly installments) or the tenures of the loans, specially big ticket loans like home loans.

To take an example: The EMI per lakh (100,000) for a duration of 20 years and interest rate of 10.00% would be 966. If the interest rate goes up by 0.25%, the EMI will go up by 16 to keep the same tenure of 20 years. So, to repay the loan of 1 lakh in 20 years, the EMI increases to 982 at 10.25%. Usually banks will not increase the EMI, but will rather increase the tenure of the loan and keep the same EMI. In that case if the interest rate goes up by 0.25% and the EMI remains the same at 966, the tenure of the loan will increase by 14 months. So, the loan which was originally for 20 years will last now for 21 years and 2 months.

This can have huge implications for home loan borrowers with recent large increase in interest rates. Let's take a typical example of a home loan of 30 lakhs (30,000,000) for a duration of 20 years.

If one had got the loan at 9%, the EMI would have been 27,000. If the rate has now gone upto 10% and the borrower wants to keep the same EMI, the new tenure will be 26 years and 2 months! If the rate instead went upto 10.5%, the new tenure with the same EMI will be 34 years and 3 months!! If the rate went all the way upto 11%, the borrower cannot pay off the loan with an EMI of 27000, he has to increase the EMI. If the borrower wants to keep the same tenure i.e. 20 years, the new EMIs would be 28980 for a rate of 10%, 29960 for a rate of 10.5% and 31000 for a rate of 11%. You get an idea! You can always ask your bank for what would be the increased EMI if you want to keep the same tenure. Or what would be the increased tenure with the same EMI.

Given a choice, should one opt for increase in EMI or increase in tenure of the loan? Usually if one can bear the burden of the increased EMI, that leads to lesser total outgo of money over the duration of the loan compared to when the tenure of the loan is increased. If you can afford it, go for a higher EMI.

Global remittance to India

Just how much do the 27 million global desis, scattered across 190 countries around the world, contribute to the Indian economy? World Bank figures show a dramatic increase of almost 162% in the remittance that India receives from overseas Indians over the last eight years. While India received nearly $21 billion from overseas Indians in 2003, the figure jumped to $55 billion in 2010.

"India received the highest remittance in 2010 compared with any other country in the world," said Dr Alwyn Didar Singh, secretary, ministry of overseas affairs during a discussion on the Indian diaspora organised by the global think tank Gateway House. World Bank data also points to the fact that India receives the highest remittance, followed by China ($51 billion) and Mexico ($22.6 billion), Philippines ($21.3 billion) and France ($15.9 billion) in 2010.

Though there was a slight dip in remittance from 2008 to 2009, it bounced back in 2010 to a level higher than in 2008. Kerala and Punjab are currently among the states which receive the highest remittance from overseas residents

Is tax on early termination fees legal

You had to terminate that cellphone contract for some reason. Sadly, you end up paying the early termination fees. But that's not all. Your final bill may include a tax on the early termination fees! Yes, getting charged tax on early termination fee does look unfair. However, it may not be illegal after all.

Is it legal?
Unfortunately, there is no simple yes or no answer for this. There are several factors at work. Such taxes are usually imposed by the state, so you need to know the state tax laws. One of the things you would want to check is whether your contract lists the early termination fees as a charge/fees or as a penalty. Ideally, one can argue that there should not be any taxes to be paid on penalty, but if it is treated as a charge by your provider, it may be difficult to argue other way. So, look up that contract.

To give an example, T-Mobile contract states "The Early Termination Fee is part of our rates and is not a penalty." You can look up the T-mobile terms and conditions here. In this case it would be hard to argue that taxes should not be applicable.

Does that mean there is no way around?
Well what you need to do is to check the tax law of the state your service is in. It could vary from state to state.