Union Budget announced on 1st February 2021  has proposed to levy income tax on interest earned by an individual on his/her contribution in excess of Rs 2.5 lakh in a financial year to all recognised provident funds(includes Employees’ Provident Fund/Voluntary Provident Fund/DSOPF).  It means any contribution of more than Rs 20,800/- per month to EPF/VPF/DSOPF will attract income tax(incl TDS) on the interest component wef 01 Apr 2021.           

As of date, annualised return on DSOPF is 7.1%. Tax at the rate of 30% will reduce the effective rate of interest to 4.97%. With inflation hovering around 6%, the real interest rate would be negative and we would be depleting our investments by more than a percentage point, year on year.

So, how and where should we invest our surplus money?

We may consider the following options:

  • Bank FD. Annualised rates of interest are around 5 – 5.5% pre tax. Post tax it works out to be in the range of 3 – 3.85%, much lower than inflation. 
  • RBI Floating Rate Savings Bonds 2020(Taxable). These bonds are offering annualised returns of 7.1% as of date with lock in period of seven years. Post tax, it works out to be 4.97% per annum. Interest rates are reset every six months based on the prevailing interest rates in the country(based on the repo rate as announced by RBI).
  • Equity Mutual Funds. Investment in equities (stocks) through equity mutual funds has yielded annualised returns in the approx range of 11-15% over the last three decades or so. These investments are linked to stock market performance and maybe volatile and carry risk over a shorter duration of time. However, in the longer time frame (five to seven years), risk and volatility get reduced to almost negligible. BSE Sensex has given a approx 13.8% compounded annual growth rate over the last three decades despite many market crashes en route.
  • Debt Mutual Funds.  Investment in debt instruments (Corporate bonds, RBI Bonds etc) through Debt mutual funds has yielded average returns in the range of 4-8% over the last decade or so, depending upon the investment horizon. 
  • Gold Mutual Funds. Investment in gold through mutual funds has yielded approx 8-9%  annualised returns over the last two decades. However, this growth is not linear and has been quite volatile in the past over a shorter period of time. Advantages of investing in gold through mutual funds are
    • No GST
    • No making charges
    • No concerns about the purity of gold
    • No worries about theft, security issues etc

Investments through mutual funds offer the following income tax advantages:

  • Equity Mutual Funds
    • Short Term Capital Gains (gains accrued by selling within one year of purchase) attract income tax at a flat rate of 15% irrespective of income tax slab
    • Long Term Capital Gains (gains accrued by selling after one year of purchase) attract income tax at a flat rate of 10% on the amount exceeding one lakh in a financial year, irrespective of income tax slab. Gains up to one lakh are nontaxable.
  • Debt Mutual Funds.
    • Short Term Capital Gains (gains accrued by selling within three years of purchase). All the gains will become part of income and would be taxed as per the income slab
    • Long Term Capital Gains (gains accrued by selling after three years of purchase) attract income tax at a flat rate of 20% with indexation (purchase price adjusted against the inflation). Effective tax rate works out to be in the range of 10-12% for a 30% tax bracket
  • Gold Mutual Funds. Taxation as per the debt mutual funds

Conclusion

  • Restrict investments to DSOPF to Rs 20,800/- per month
  • Invest the balance amount through mutual funds as per your risk profile and financial goals
  • Invest for a longer time duration to reap  the benefits of compounding
  • Please remember that we need to beat inflation to grow money in the real term

Please call me at 7341137190 or 9968074002 if you need any assistance in the redeployment of your hard earned money. Alternatively, you may book 20 minutes no charge consultation with me at (https://calendly.com/rakeshgoyal)

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