Sunday, 19 February 2012

I made a mistake : Fixed returns can lead to Early Retirement

Several months ago, I had stated to my wife, quite brashly if I may add, that debt-like returns would not find any place in our retirement portfolio.  I have been in a tearing hurry to grow our retirement corpus and I thought that the slower growth rate of debt-like investments, when compared to equity based investments, was something I could not tolerate.  In fact I was so convinced about my logic, that I even posted a blog entry justifying my position.  I could not have been more WRONG!!  However, like all good things, ones financial strategy is also never 100% right, and there is always room for improvement.  I have now realized my mistake, and made room for some more fixed income into our retirement portfolio.  There is one key recent investment opportunity though that triggered my change of heart.  If you are a keen follower of personal finance, then you already know what I am talking about!  Yes, I am of course talking about ...
... tax free infrastructure bonds.  But before I get into the details, here are some related thoughts.  The biggest fear I have with building a retirement portfolio is taxes.  Taxes can take a huge bite out of my withdrawals from the retirement portfolio when I eventually need the money!  I cannot afford to pay anywhere from 10% to 30% of my withdrawals to the government.  Unfortunately there are only a few ways in which you can protect your retirement portfolio from taxation.  Your EPF and PPF contributions follow the EEE concept.  This means that the money going into PPF/EPF is not taxed, it grows tax free, and is not taxed when you withdraw the money.  However, there is a maximum limit to how much money you can save this way.  PPF maxes out at Rs1Lakh per year (was Rs70,000 earlier; increased to Rs1Lakh since Dec'2011)  EPF is limited to 10% of your basic salary if you are a salaried employee.  My next target is typically the long term capital gains route.  Currently long term equity capital gains are taxed at 0%  So you can stash all of your retirement portfolio into equity based investments, and withdraw them via SWPs (Systematic Withdrawal Plans) without worrying about taxes (assuming naturally that you have held these investments for more than a year)  However, the first problem with this approach is that equity based investments tend to be high risk, and you do not want to be withdrawing from your equity portfolio in a market downturn.  Also with the new proposed DTC (Direct Tax Code) around the corner, this benefit might be withdrawn at any time.

Dividend income is the other possibility.  You can currently invest a large part of your retirement income in dividend yielding equities (either through directly buying high dividend yielding stocks, or through dividend mutual funds) and live off the yearly dividends that they generate.  However, though dividend returns are currently not taxed, that could also change once the DTC is approved.

I am not aware of any other means currently to protect your retirement withdrawals from the taxman.  In this scenario, the announcement of the tax free bonds came as a welcome relief, and really perked my interest.  Back in 2003, the government of India had announced RBI relief bonds at 6.5% tax free interest.  Unfortunately at that time I was not focused on my retirement planning.  As I learned more about the taxation policies, I began to realize that there were very few avenues to save money, and build a portfolio that could generate sustainable and predictable yearly returns, without paying a fat share to the government.  The US allows for investments via ROTH IRAs.  This structure, allows you to channel your investments (upto a limit of course) through it such that your withdrawals are tax free.  The ROTH IRA is basically a TEE structure.  The money going in is already taxed, but once inside the structure, it can grow tax free, and can be withdrawn tax free.  This is a powerful method to rapidly grow your investments.  In India the only TEE structures are life insurance policies, ULIPs, and pension plans.  Pension plans and traditional endowment policies are typically linked to fixed return instruments, and hence their returns tend to be low.  ULIPs are no different from long term MF investments from a taxation perspective.  India currently does not provide a formal TEE structure like the ROTH IRA. 

Therefore when the tax free bonds were recently announced, I was pleasantly taken by surprise.  I mentioned to my wife the moment I noticed this investment avenue that we should take full advantage of it.  I had completely forgotten my earlier statement that I would never include debt-like instruments in my retirement portfolio!!  The opportunity to lock in tax free returns of over 8% for 15 year periods was too good to pass up.  I will not get into the details of the tax free bond offerings from NHAI, PFC, HUDCO and IRFC here.  You can easily find tons of literature describing the various aspects of these bond offerings on the internet.  Suffice it to say that guaranteed pre-tax returns of upto 12% per annum (for folks in the highest 30% income bracket) were too mouth watering to pass up.  Obviously several people thought the way I did.  The HNI allocations of all these bond offerings were over-subscribed within days.  Fortunately all of them had separate allocations for retail investors like you and me.  There was a limit of Rs5L per bond offering in the retail category, which I thought was high enough for most retail investors.  In case you had more money available to invest, you could have spread 20L across the 4 offerings, and a total of 40L if you and your wife applied separately.  At 8.6% tax free returns, you can generate ~Rs29K per month tax free for the next 15 years guaranteed!!  This is possibly the highest guaranteed returns post-tax that you can generate across any existing TEE schemes. 

No wonder I had to admit my mistake, and change my retirement investment philosophy.  My only regret at this time is that I could not free up enough capital to invest in this tax free offering.  If there are more tranches of such offerings in the future, I fully intend to watch out for them, and plan upfront to free up some more cash to invest in such risk free and tax free opportunities.  Did you capitalize on this opportunity for your retirement portfolio?  Such no-brainer opportunities do not come very often!  It would be interesting to know how many of you participated in this bond offering.  Let me know.


  1. I too am using this opportunity to lock in the recent interest rate @ 8.71% being offered by REC for 15 years. The recently tax free saving bond offer a limit of Rs 10 lakhs per person 2013.... The government has approved thirteen PSU's to issue tax free bonds. Thus with my wife and myself individually applying we could ideally invest a total of ten lakhs each taking the total to two crores sixty lakhs. This amount is a very high figure for any middle class. Thus every family can invest to the amount they are looking to generate as a fixed amount every year

  2. Are there any more offering coming in market in next few months ..?

    1. I dont think so Banker. These tax free bonds were very popular when they were introduced for a brief period. I doubt if we will see these again in the near future. In the meantime your best bet is corporate bonds which provide a high interest rate, but not taxfree.

    2. I am planning to retire at age of 40 with 1.5 cr now I am 34
      will it enough and how we can get returns per month

  3. I don't care if the market is up or down. what i'm looking for is a bargain with us.
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