How to earn more in the golden years

Depending on your liquidity requirement, invest in the right debt instruments.

When interest rates start falling, senior citizens are impacted the most.

They are unable to take riskier bets such as putting a large amount of their portfolio in equities. And, the returns on fixed instruments, usually recommended for them, start slipping.

Banks have recently lowered interest rates and are now offering fixed deposits (FDs) between 7.5 per cent and 8.45 per cent for the elderly.

There's another issue regarding the adverse impact. With the Reserve Bank of India (RBI) recommending to the government that small savings rates be reviewed (read, aligned with the lower interest rate scenario), returns on instruments that traditionally give higher returns might get lower (if the government accepts the recommendation).

Small savings schemes include the public provident fund, post office senior citizen savings scheme (SCSS), post office time deposits and others.

At present, the interest rate offered on SCSS is 9.3 per cent and on a five-year time deposit account is 8.5 per cent. In comparison, the highest interest rate the State Bank of India offers on its term deposit is 7.75 per cent for senior citizens (and 7.5 per cent for others).

Tax benefits of investment options

"The central bank has said the long-term inflation rate in India will be below four per cent. This means the rates on small savings schemes will come down. That's why the central government is pushing for pension products, as there's no social security in India," says Rajiv Jamkhedkar, founder and managing director of Serengeti Ventures, a financial planning company.

Sticky situation

If small savings schemes do get a rate revision, those who rely on fixed income instruments are bound to feel the pinch of inflation.

Though the August consumer price index was at 3.66 per cent, RBI has set a target of six per cent for the next financial year. Experts say, with the inflation in developing countries like India, it is very difficult to predict the corpus required for a person on retirement.

"A corpus of Rs 1 crore today would only last a person for 12 to 15 years if he or she maintains the present lifestyle," says Suresh Sadagopan, a certified financial planner. If a person retires with a corpus of Rs 1 crore today, after 15 years he would need this money to grow to Rs 1.8 crore to sustain the same lifestyle at an average inflation of four per cent. But, if inflation is at six per cent, he would need around Rs 2.4 crore. So, what are the options?

If you are lucky and get to lock your money at the prevailing interest rate, there's nothing like it (See table: Investment Options). If not, there are three investment strategies you can look at.

SCSS

Financial planners suggest SCSS works out to be the best option for seniors and they should exhaust the maximum investment limit of Rs 15 lakh in this.

D Sundararajan, a certified financial planner, says that this should be the first option one should exhaust. If the both partners are above 60, they can invest a total of Rs 30 lakh. While investments are eligible for tax deduction under Section 80C, the interest earned is fully taxable as income.

Debt funds

These are a better option than investing in a bank FD and annuity plans, if you manage it well.

Debt funds can get volatile like equity and carry the risk of companies defaulting on payment, as happened recently when Amtek Auto couldn't repay JPMorgan AMC.

That's why a retiree should keep a mix of short-term and medium-term funds, and also opt for schemes with lower risk such as liquid or income accrual.

Seniors use a systematic withdrawal plan (SWP) in debt funds. They should opt for a pre-fixed amount from the scheme at a regular interval depending on the requirement.

"The primary benefit of using SWPs is significant tax savings vis-a-vis bank FDs and it is also a superior alternative to pension plans of insurance firms," Sadagopan says.

For tax purposes, short-term capital gain is calculated by taking the difference in net asset value (NAV) from the time of investment to the time it is withdrawn and multiplying it by the number of units cashed out.

The gains are added to the income and taxed at slab rates. The SWP strategy can benefit investors in all tax slabs.

Assume a person in a 30 per cent tax bracket invests Rs 1 lakh in a debt mutual fund and in a bank FD, and that returns from both are 8.8 per cent.

The investor can choose to withdraw 2.2 per cent per quarter from the debt fund, approximately what one would expect as interest income each quarter from the bank FD.

The tax to be paid in the case of the FD on an interest income of Rs 8,800 is Rs 2,719. In contrast, the short-term capital gains tax for debt MFs on a withdrawal of Rs 8,987 comes to only Rs 146.

One more benefit for investing in a debt fund is that these are positively impacted when interest rates are falling, whereas interest on bank FDs decline.

In the case of annuity, the payment is taxed as income. It also has other disadvantages - the disbursal rate in an annuity plan is typically 5.5-6.5 per cent a year.

The returns will work out to be lower when one accounts for taxation. Also, annuities cannot be stopped, which can be a big handicap when a person wants to access his or her principal for some emergency.

Tax-free bonds

For those in the 20 per cent and 30 per cent tax bracket, these work out as the better long-term investment, compared to a small savings scheme.

The most recent issue of NTPC, concluded on September 30, offered 7.62 per cent for a 20-year investment period.

This means those in the 20 per cent tax bracket are getting an effective rate of about 9.5 per cent and for those in 30 per cent, it will be over 10.8 per cent.

NTPC had an annual payout option only. Many more government companies in the infrastructure space are planning to raise money through this option. 

Equities

This is one of the few investments that have beaten inflation consistently over the long term. In the current scenario, it is imperative that seniors opt for the instrument.

"They can invest some part (say 20-30 per cent) of their corpus that they won't need for the next six-seven years. This will help to grow their existing funds over time," Abhishake Mathur, head - investment advisory services, ICICI Securities.

He says that this should be done in staggered manner. Sundararajan suggest that in case they cannot leave it untouched, then they should look at balanced funds with a dividend paying option.

If the government is revising small schemes rates because of lower inflation, elderly will continue to get some real returns on their investments, says Mathur. 

Expenses have more than doubled in six years

A 64-year person gets around Rs 40,000 a month from his corpus of Rs 30 lakh, entirely in bank FDs and small savings schemes, and house rent. Cost of living has more than doubled since he retired six years earlier. With family responsibility still on his shoulders, he now plans to sell his second home to make ends meet. As he already has investments in SCSS and other debt instruments, financial planners say he should allocate some of his proceeds from house sale to a balanced fund.