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Mental accounting imposes discipline on the manner of your spending

Applying thought

Separate your pool of money into buckets

Start teaching budgeting to teenaged or college-going children

Resist the temptation to make ‘impulse’ purchases

When I caught up with some friends, a curious discussion on money and savings came up. I asked them how they treated their money — whether as a big pile and spend from that or bucket them into sources and spends. One friend said, “cash in, cash out and if lucky, some savings.” Another friend said, the salary is usually for household expenses and EMI. The rental income is set aside as an investment for daughter’s education. If you did the latter, you may be engaging in the interesting activity of mental accounting.

Instead of treating all money as purposeless blobs that transit through your account, if you separate your pool of money into buckets, either based on the source of the money or what you intend to do with it, you are lending purpose to the unit of money. In the world of savings and investments, this can be a smart thing to do.

Spending limits

Let us look at the benefits of mental accounting when it comes to spending. In the days when credit or debit cards were not available, you may have seen your father or grandfather put money into neat covers and write ‘rent,’ ‘milk and vegetables,’ ‘electricity’ and a handsome ₹100 for emergencies. This mental accounting imposes discipline on how we spend, and more importantly, provides a tremendous mental reward system when you actually save anything kept for any of these buckets. It encourages you to save, even if it is to reward yourself with some other purchase.

While your spending today happens through cards or UPI, you can still use apps to fix a limit and keep track of your spending — category-wise (clothes, entertainment, food etc.). It is no different from tracking your mobile data usage after fixing the limit.

If you are a parent with a teenager or a college going kid, this could be a great way to start teaching budgeting and the need to save; giving them some incentive for saving. Needless to say, you could do with the same discipline too!

A far more significant benefit of mental accounting, if used well, happens in investing. Three things happen when you invest with goals in mind: one, you know how much you need to save and fine-tune your savings, you know when you need to achieve it and most importantly, you know what financial products to choose, to save for the goal. Most of you go to your adviser or relationship manager saying you have some surplus and want to invest. You seldom have an idea on what you will use it for (here you treat money as a common pool), or when you will need it. Let us suppose you are sold a money-back policy. Three years hence, you are short of money to pay the hefty fee demanded by your child’s education institution and want to surrender the policy. You are told you will be given just 30% of the premium paid, excluding the first year. That essentially means you lose out even the money you paid as premium besides the fact that the money would not help you meet the immediate financial goal. So, what went wrong? You did not do the mental accounting of segregating the purposes for which you were investing. If you had done this, the purpose would have had an end date. If you knew this end date, then you would have chosen the right investment product and would have got the money with some returns (without deep discounts or losses) when you needed it. If you knew your medium-term goal was to get admission in a premium school for your child in 2-3 years, then you would have an idea on how much is needed and you could have followed up with saving more.

Also, the question of locking it into long-term insurance products or high-risk products and losing money or getting a poor deal would not even arise. For example, in this scenario, I’d simply tell you to go with low-risk deposits or fixed income product, since you have no leeway to go for high risk or long-term products. This is the key ‘make or break’ point for your financial goals and wealth building. Having no goal often leads to wrong choice of products.

The other big advantage with mental accounting is that it reduces the temptation of digging into your investments for impulse purchases. For example, I knew an investor who was saving diligently for the higher education of his two children. We specifically tagged the portfolio as education portfolio of his son and daughter respectively and tracked them separately. He once told me he opened his portfolios on his app to withdraw ₹12 lakh to buy a new car. But when he saw the ‘education’ tag screaming at him, he closed it. He postponed his car buying indefinitely. That to me, is the benefit of mental accounting. You stay committed to your goals. Try starting off today with this simple action of segregating the money you get into specific purposes.See the difference it makes to your life, five years from now.

(The author is co-founder, Redwood Research)

Annuity policies come with an array of options

Long innings: Purchase price paid towards an annuity includes a risk premium for longevity. Arunangsu Roy ChowdhuryArunangsu Roy Chowdhury

Up to ₹50,000 per year of annuity purchase price brings you tax deduction under Section 80CCC

This is over and above the ₹1.5 lakh under Section 80C for life insurance premiums

Having decided to buy an annuity policy, you can choose from various options. Before that, let us look at the tax implications.

Up to ₹50,000 per year of your annuity purchase price brings you a tax deduction under Section 80CCC of the Income-Tax Act, 1961. This is over and above the ₹1.5 lakh under Section 80C for life insurance policy premiums, Employee or Public Provident Fund and so on. Any contribution to the National Pension Scheme will also come under this ₹50,000 umbrella.

On the vesting date, you can commute up to a third of the accumulated amount without tax and the balance is applied towards the annuity. The annuity itself, the pension payments you receive after vesting date, are taxable as part of your income. This is important when you plan your post-retirement income flows.

How would you like to receive your annuity is the next decision.

This is a choice you have to make while purchasing the annuity and cannot change.

There are about a dozen options that most life insurance companies offer. The simplest one is annuity for life, which involves annuity payout until your lifetime. This can be on a single life or joint life with your spouse. You can opt for annuity guaranteed for a certain period (5, 10 or 15 years for example) and then for life and the payout will be for the longer of the two. Then, there is annuity of any of the above options with return of purchase price to your nominee. Some firms offer options of a specified portion of your purchase price to return, 50% or 100%, and options where the annuity rises at a specified rate year-on-year, to match rising costs of living. All these choices impact the quantum of your annuity.

Immediate annuity

A 45-year-old would pay ₹6 lakh or so for an immediate annuity of ₹43,000 a year for his lifetime.

Should he want a guaranteed pension for 20 years and then for a lifetime, the purchase price would be a bit higher at ₹6.5 lakh. With return of purchase price, an annuity for life costs ₹7 lakh approximately. In case of a critical illness or an accident leading to permanent disability, your annuity policy can come to your rescue by way of return of purchase price.

This is a rider, an additional cover you have to buy at the inception of the policy.

These optional extras differ by company and policy and can cover accidental death and dismemberment, waiver of premium, etc.

One important decision you have to make is whether you want a unit-linked annuity. In a linked annuity, your premium over the years is invested in capital markets and the corpus that results on the vesting date will be your purchase price. So, your capital available to invest in an annuity is subject to market risk, something you have to be aware of.

One question that comes up in the mind when you calculate the ‘return’ rate on an annuity is, even a bank fixed deposit appears better. Maybe, but don’t forget that the premium or purchase price you pay towards an annuity includes a risk premium for longevity.

(The writer is a business journalist specialising in insurance and corporate history)

Compare rates and buy the policy online

Across the country, there has been a mad rush to renew lapsed insurance policies by motorists, thanks to the new Motor Vehicles Act that has imposed heftier fines for those driving uninsured vehicles. Apart from the fine, there are other reasons why you should renew your lapsed motor insurance policy.

One, if you hit a third-party vehicle and the vehicle is damaged or the person driving it suffers bodily injury or dies and there is a legal proceeding on you, you will have to settle it personally. Note that the liability is unlimited. Further, if you do not renew your policy on time and it has lapsed for more than 90 days, you will be losing the no-claim bonus.

Buying motor insurance online is very simple today. You can either go to the same insurer’s website, login with the policy number and renew it or look for a new insurer and take a fresh policy. You can login to the websites of online aggregators such as Policybazaar.com, Coverfox Insurance and Renewbuy.com, and compare the premium rates offered by different insurers.

After you select your bike’s manufacturer, model and variant, and the year of registration, and specify the RTO where it was registered, the site will throw up premium rates offered by different insurance companies. With the new-age insurers — Digit and Acko — buying online motor insurance is even simpler, involving just three or four steps. But that said, with traditional players, there is the comfort of a good track record in settlement. If you want to save some money, you can buy just the third-party cover, which is mandatory under the law, instead of a comprehensive cover that includes own damage insurance. A third-party insurance will cover only the legal liability arising out of damage to the property of a third-party or bodily injury/death of the third party.

Another way to save on premium is to take a lower insured declared value or IDV. This is the market value of a vehicle, less depreciation (depending on the age of the vehicle). Your bike/car will be insured for this value. Note that, on damage to the vehicle, this is the maximum amount the insurer will pay you. The insurance aggregator sites also will give you the option of to go for a lower IDV.

While you will be saving on premium by going for a lower IDV, you may end up paying from your pocket for repair in case of damage to the vehicle if it is under-insured.

Q. I have opened a capital gains account with a balance of ₹20 lakh. A major part of this would go to my builder who will be handing over the possession of our apartment shortly. Please let me know if the income tax authorities will allow me to use the balance only for interior wood work, false roofing or also for electrical appliances.

SVS Mani

A. As per section 54, the proceeds of capital gains are to be used for purchase or construction of house property. Such proceeds, in your case, deposited in the capital gains scheme account are to be utilised for payment to the builder and for such other expenses to make the house habitable and not for other expenses. In casethe amount is not fully utilised, then the balance is to be treated as long-term capital gains in the year of possession of the property or at the end of three years whichever is earlier.

It is to be noted that the amount deposited in the account is to be utilised in the aforementioned manner within three years from the date of transfer of the original asset.

Q. I am an NRI and have invested ₹2 crore in mutual funds (MFs). If I become a resident Indian and opt for monthly dividend option with a return of 10%, what will be the tax amount that will be deducted from my monthly dividend income. Apart from this, is there any other tax I need to pay to the Government of India?

S. Ramanathan

A. Dividend received from registered mutual funds are exempt from income tax. However, redemption/sale of mutual fund units attract income tax in the following manner; for equity-oriented mutual funds, redemption within one year from purchase is treated as short term capital gains and tax is payable at 15% on such gains plus cess and surcharge, if applicable; in case the said nature of funds are redeemed post one year, it is treated as long-term capital gains and tax is payable at 10% on such gain plus cess and surcharge, if applicable if the quantum of such gain/s exceed ₹1 lakh.

For debt mutual funds, on redemption within two years, tax is payable as per income slabs for individuals/senior citizens/super senior citizens on such gains plus cess and surcharge, if applicable. On redemption post two years, tax is payable at 20% on such gains plus cess and surcharge, if applicable

Q. I have been an NRI for the past 28 years and returned for good over two years ago. What’s my NRI/RNOR status?

Vijayakrishnan

A. For determination of your residential status in a particular financial year, the first criterion would be to calculate the number of days you were in India in a particular year. If it exceeds 182 days in all, you become a resident for that year. The next step would be determine the type of resident, whether you qualify to be a resident but ordinarily resident (ROR). You must have been a resident of India for at least two out of ten immediately previous years and have stayed in India for at least 730 days in immediately seven preceding years. If you fail in anyone of the two conditions, then you will be resident but not ordinarily resident (RNOR).

On the taxability of income, if you are a resident/ROR, income earned by you from anywhere in the world is taxable in India subject to double taxation avoidance agreement provisions and if you are a RNOR, only those incomes earned by you which are either received or accrued in India are taxable in India

(The author is partner GSS & Associates, Chartered Accountants, Chennai)

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