Are credit cards all that bad?

Let me clarify at the beginning of this post that I am not some telemarketer or a bank employee who is trying to sell you credit cards. J

While the use of plastic money has gained popularity in India, there is a general perception that they are bad and should be avoided. Credit cards could pose a threat to your long term financial security if used irresponsibly. And, if used prudently, you could reap a lot of benefits without piling up unnecessary debt. These perks are:

1.Free money: You can enjoy the float without having  to pay interest until the due date of the payment cycle.

2.Security: Your cash is lost forever in case of theft but not your credit card. You can immediately contact your credit card issuer who will cancel it and issue a new one.

3.Emergency: In case you do not have enough liquidity in emergency situations like car breaking down or some medical crisis, a credit card will be helpful.

4.International Travel: If you travel often across the globe, it is much more convenient and safe to use a credit card.

5.Loss protection: In certain cases, you have the right to withhold payment for unsatisfactory goods or services.

6.Incentives: A reward program entails accumulating points based on the purchases you make on your card. These points can be eventually redeemed for a wide array of options including travel, dining, electronic items, fashion, air miles, shopping vouchers, etc. There are also cash reward points in certain cards which can be redeemed for cash. Certain cards provide a complete waiver on fuel surcharge at select petrol pumps.

7.Insurance: A comprehensive air accident insurance cover is provided in many cards.

However, a word of caution comes with all the goodies in using a credit card. Do not just pay the minimum amount and roll over the outstanding balance. Pay the full loan amount or else you will end up paying a hefty interest on it (ranging from 24 to 40 per cent per annum).  Also, the additional purchases you make in the subsequent months will not enjoy a grace period and they will be charged interest from the date of purchase. 

Best still would be to avoid a situation where you are unable to pay the full amount when you buy something on credit. For this, make sure you budget your finances accordingly and are able to pay the amount by the end of the grace period.

To summarise, do not use credit cards to spend money you do not have or cannot afford. Otherwise, it will limit your future buying power and ruin plans of financial freedom.

 

Invest via your parents/children and save tax :

With the July 31 deadline nearing for filing tax return, we rush to invest in the conventional options to save on tax.  Investing under S/80C and claiming medical expenses and house rent allowance are some common modes of saving tax.The human tendency to procrastinate till the end hour in filing returns does not allow us to explore some not so common options for tax planning.

For instance, have you pondered that by investing in your parents and children’s name, you can broad base your income and reduce your tax incidence. If you are investing directly in your name, your tax liability will increase and might push you in the highest tax bracket.  Taking an indirect route by gifting your parents and major children money and assets for investment is the simplest way to save on taxes.

As per the Indian tax laws, gift received (in cash or kind) from relatives do not attract any tax. Relatives here include spouse of the individual, siblings, brothers and sisters of the spouse, brothers and sisters of the parents and any lineal ascendant or descendant of the individual or the spouse. Though gifts are not taxable in the hands of the recipient, any income generated from the gift attracts taxation. However, income generated from the gift given to spouse and minor children is clubbed in the total income of the donor.  For instance, you transfer Rs.1 lakh to your spouse or minor children and it is invested in a fixed deposit yielding 9 per cent per annum. The yearly interest of Rs.9,000 will be clubbed in your total income for the purpose of taxation.

If you want this interest earned to be treated as independent income, then you can invest the surplus money or assets in the name of your parents and/or major children. If your parents are above the age of 60, they do not have to pay annual income upto Rs.2.5 lakh each. Assuming they don’t have any other source of income, you can invest up to Rs.50 lakh ( upto Rs.25 lakh each) through your senior parents and earn a tax free income of Rs.5 lakh (assuming a 10 per cent annual return).

Similary, if your parents are above the age of 80, they are entitled to a basic exemption limit (BEL) of Rs.5 lakh, each. So you can invest up to Rs.1 crore (upto Rs.50 lakh each) in their name and indirectly earn a tax free income of Rs.10 lakh.

Investing in your children’s name is also simple if they are major in age and not earning. In the case of daughter, interest income earned from your gifted money will not attract tax until it crosses the BEL of Rs.1.9 lakh. Similarly, annual interest earned through your son will not be taxable until it exceeds Rs.1.8 lakh. 

This prudent mode of gifting money or assets to reduce taxes also helps in making your family secure in the case of some unfortunate event. However, one hitch in this strategy is that you may be uncomfortable gifting a lot of money to your major children. As you will be giving money on mutual trust, be sure that the recipient does not take advantage of it. So start planning your taxes from the current financial year by making the most of the gifting provisions.

Keep your insurance and investment goals separate :

We do a lot of due-diligence before shopping for an expensive item. We check out various shops to explore options and bargain for a value buy. Unfortunately, we do not take much effort in buying our financial products.

The basic financial literacy in India is very shallow and confined to the knowledge of different products available in the market. The basic notion ingrained in Indian minds is what returns to expect when they buy a financial product. Nothing wrong with that. However, it should not be at the cost of certain basic priorities. Like we pay for our regular household expenses, insurance is one of the basic necessities of life. In fact, the rule of thumb is that after paying your life insurance premium, the surplus money on hand must be invested in mutual funds, equities, etc. Unfortunately, insurance is perceived as an investment. Outlined below are some real-life examples which will reveal the basic misconception in people’s minds about life insurance. I found some funny too:

A. A life insurance policy (endowment) was sold to my       friend (working) when she was 25 years old. She is filthy rich, hails from a business family and does not contribute to run the household. Do you think she required life insurance when she has no dependants?   

B. One of my highly qualified friends bought a Rs.3 lakh insurance cover for his car. Did you know what his total life insurance cover was – Rs.2 lakh. Strangely, his car seemed more valuable than his own life!

C. Another friend bought an expensive ULIP which she did not even need. Why did she buy it, because she could not say no to the agent as she was her close relative!  

D. A Unit Linked Insurance Plan (ULIP) was sold to a senior citizen, who was paying hefty premiums on it. Now, does he require an insurance cover in old age when his children are well settled and looking after him? The agent who sold the ULIP argued that it was an investment product sold to him, not insurance. Imagine an expensive and risky equity product sold to your parents during their retirement years!  

E.While buying an insurance policy, the first question  that my neighbour asked the agent was how much return can he expect from the policy.  

Apparently, the loss of human life and its financial implications for a family seem so irrelevant when one refers to these instances of buying life insurance. Technical details like how much cover is adequate (refer to my article dated 22 June, 2011), number of dependants in family, existing liabilities, etc are hardly discussed. By keeping investment in mind, many people end up buying insurance which is not in conformity with their needs and goals. They pay hefty premiums on such products but still remain under-insured.

When you ask people about their investment portfolio, they invariably end up mentioning money back and endowment policies. In such policies, the family will get the sum assured and the maturity value in the event of loss of life during the policy term. If the insured survives the policy term, he gets the surrender value. However, under these policies popularly pitched by agents, hefty commissions are paid out of your investment. Thus your savings portion accumulates slowly leading to abysmal low returns of 5-6 per cent, not even beating inflation.

On the other hand, a term policy is a pure insurance cover. It is meant to cover only for the risk of life loss and does not pay you any money against the premiums paid. The commissions on term policy are low and are thus not heavily promoted by agents. It is the cheapest form of insurance offering the best combination of coverage and cost.

The difference in the premiums of a term policy and an endowment policy are quite stark. Consider this: If a 30 year old buys an endowment policy of 10 lakh for a 20 year term, the annual premium paid would be Rs.47,950. If he buys a term policy for the same cover and term, he will have to cough out just Rs.3,230. This is just seven per cent of the premium cost of the endowment policy. So if a term insurance is bought and the premium difference is invested in other option like PPF, equities, mutual funds, gold, etc., the returns are bound to be much higher. 

That does not mean endowment policies are not suitable to buy at all. If you can afford to pay heavy premiums, have a conservative risk profile and are content with minimal returns, you can go for endowment/money-back policies. But make sure you are adequately covered. One can also buy a huge term cover plan and balance it with a small endowment cover.

So do your homework and ask your agent the relevant questions. Evaluating the financial risk for the loss of your life is more crucial than focusing on how much return your insurance product earns for you.