Budget 2014: Short-term goal planning is now easy!

The tax arbitrage between debt mutual funds and fixed deposits/recurring deposits does not exist for less than 3 years.  This announcement, made by finance minister yesterday, has left many investors and mutual fund distributors worried.

For those who believe that investing has to be done with a future expenditure in mind, this is welcome news. Or at least it ought to be.

Planning short-term goals (less than 3 years away) has now been made easy! I would say even trivial.

Prior to the announcement yesterday, the holding period for long-term capital gains to be applicable was one year.

So people who wanted to plan for short-term goals (above 1 year to few years) were confused about the instrument of choice:

FDs, RDs, liquid fund, ultra-short term fund, banking debt fund, income fund, short-term gilt funds, FMPs (incl. double-indexation) etc.

This confusion split over to even those whose goals were less than 12 months away!

Now the holding period for long-term capital gains has been made 3 years.

Therefore for all durations less than or equal to 36 months, the taxation rule for debt mutual funds is the same as that for  FDs/RDs.

So no more worrying about what to choose!

If your goal is less than 3 years away,

  • choose a fixed deposit if you have a lump sum to invest
  • choose a recurring deposit if you want to invest monthly

As simple as that.

Pondering, 'what gives the highest post-tax return?' for 3 years or less is now complete waste of time.

Since the power of compounding is not relevant for short durations, worrying about high returns was always a waste of time!

Remember that debt fund returns (incl FMPs) are not guaranteed.

There is no need to take on that volatility when there is no tax advantage.

Short-term goal planning is now trivial due to lack of choice!

Acche din for financial planning! Not so Acche din for fee-based financial planners and mutual fund distributors?!

What about arbitrage funds? Are they not relatively risk-free and tax-free after one year? Read more about arbitrage funds here

They can definitely be used if the goal is more than a year away. But please note that on a day to day basis, these funds lose money  on a regular basis. The loss will be small.  They have generated negative returns over a month or even over a quarter.

So far they have not lost money over a year. But they could! So tread carefully. Their long-term capital gains maybe taxed in future!

Now let us consider some other implications of the budget.

Dividend Option

How about choosing daily/weekly/monthly divided reinvestment option for short-term goals or for storing some cash intended for equity investment when the market dips?

Unfortunately the effective dividend distribution tax has now increased by at least 2% or so (from what I read; my own calculations point to a much higher increase). According to Deepak Shenoy of Capital Mind, it is about 6% more. That is an effective DDT of 28.2%. I will need to understand this better.

For those in 10% and 20% slabs it makes no sense to choose the dividend option as before.

The advantage for those in 30% slab is still present but has reduced by a huge margin!

Liquid funds funds with periodic dividend payout or reinvestment is still an attractive option for those in the 30% slab, provided they use it for the right purposes.

Retirees/Senior Citizens

Those who are managing retirement expenses with debt funds would feel the pinch, especially if they redeem from a large corpus each month. They will need to wait 3 years for the indexation to kick in.

Now a  significant portion of the corpus will have to be shifted to debt funds 3 years before retirement to optimize monthly withdrawals. This may not always be possible.

Investors who have held a debt fund many years before retirement  may probably adapt to this ruling better.

 

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21 thoughts on “Budget 2014: Short-term goal planning is now easy!

  1. Nanda Kishore M

    Mr. Pattabiraman, thanks for making concept so simple. I too am big fan of KISS (simplicity is the ultimate sophistication). However I feel we can consider Arbitrage Funds Direct Plan Dividend option instead of FD. This will even shield possible change in LTCG taxation in future from retrospective effect.

    Reply
  2. Nanda Kishore M

    Mr. Pattabiraman, thanks for making concept so simple. I too am big fan of KISS (simplicity is the ultimate sophistication). However I feel we can consider Arbitrage Funds Direct Plan Dividend option instead of FD. This will even shield possible change in LTCG taxation in future from retrospective effect.

    Reply
  3. Rajendra Dixit

    Hi Pattabiraman Murari, for retired persons with no income other than what is being generated from debt funds, would not be greatly affected by this draconian new rule. They just need to invest in growth plan of safe debt fund scheme in the category of ultra short or at max short term debt funds. From that investment, one can withdraw the required amount for expenses every month. The whole withdrawn amount is not taxable - only the growth is taxable. To take an example, if one needs 30K every month, then (for simplicity) assuming 10% annualized returns, only 3K of the withdrawn 30K would be taxable. So for complete year only 36K would be taxable income which is well below tax limit. If this investment is kept for 3 years then it will qualify for LTCG and hence indexation benefit.

    As you have mentioned, debt funds are not guaranteeing any fixed returns hence assuming that you would keep on getting same returns even from stable debt fund will be mistake. However looking at past data, you can assume that your returns would be in line with nationalized bank's FD returns with added benefit of liquidity.

    Reply
  4. Rajendra Dixit

    Hi Pattabiraman Murari, for retired persons with no income other than what is being generated from debt funds, would not be greatly affected by this draconian new rule. They just need to invest in growth plan of safe debt fund scheme in the category of ultra short or at max short term debt funds. From that investment, one can withdraw the required amount for expenses every month. The whole withdrawn amount is not taxable - only the growth is taxable. To take an example, if one needs 30K every month, then (for simplicity) assuming 10% annualized returns, only 3K of the withdrawn 30K would be taxable. So for complete year only 36K would be taxable income which is well below tax limit. If this investment is kept for 3 years then it will qualify for LTCG and hence indexation benefit.

    As you have mentioned, debt funds are not guaranteeing any fixed returns hence assuming that you would keep on getting same returns even from stable debt fund will be mistake. However looking at past data, you can assume that your returns would be in line with nationalized bank's FD returns with added benefit of liquidity.

    Reply
  5. Kalyan Sundar

    Pattabiraman Murari I was imagining this speech as a fast forward during next budget :
    “In light of the fact, that there is too much participation in arbitrage funds by the HNIs and corporates, I hereby propose that the returns from Arbitrage funds will be taxed on par with the Debt funds. Retail investor has hardly participated in this and the arbitrage gained by the HNIs and corporates will have to be diverted to our banking system”. Moreover, we need to reduce speculation and move on to long term investment. If the HNIs and corporates want, we will send more trucks for them to load their crores of 5 Rupees and 10 Rupees notes for buying kisan vikas patras.”
    That way, at least the economy will be simulated with buying of more trucks!!!.

    Reply
  6. Kalyan Sundar

    Pattabiraman Murari I was imagining this speech as a fast forward during next budget :
    “In light of the fact, that there is too much participation in arbitrage funds by the HNIs and corporates, I hereby propose that the returns from Arbitrage funds will be taxed on par with the Debt funds. Retail investor has hardly participated in this and the arbitrage gained by the HNIs and corporates will have to be diverted to our banking system”. Moreover, we need to reduce speculation and move on to long term investment. If the HNIs and corporates want, we will send more trucks for them to load their crores of 5 Rupees and 10 Rupees notes for buying kisan vikas patras.”
    That way, at least the economy will be simulated with buying of more trucks!!!.

    Reply
  7. Kalyan Sundar

    Pattabiraman Murari I was imagining this speech as a fast forward during next budget :
    “In light of the fact, that there is too much participation in arbitrage funds by the HNIs and corporates, I hereby propose that the returns from Arbitrage funds will be taxed on par with the Debt funds. Retail investor has hardly participated in this and the arbitrage gained by the HNIs and corporates will have to be diverted to our banking system”. Moreover, we need to reduce speculation and move on to long term investment. If the HNIs and corporates want, we will send more trucks for them to load their crores of 5 Rupees and 10 Rupees notes for buying kisan vikas patras.”
    That way, at least the economy will be simulated with buying of more trucks!!!.

    Reply
  8. Rajendra Dixit

    Pattabiraman Murari - You would be surprised but actually tax outgo from FD would be much higher than from debt fund. Let me take an example for which I would assume 10% returns from both FD and debt fund (for simplicity I am taking 10%). Another assumption - there is no other income source. Lets say you require to generate 50K per month or 6 lakhs PM income is required so you would require 60 lakh corpus. Now income generated from FD would be added to your income and taxed at your rate of tax. So total of 3.5 lakhs would be taxable income from FD. As against that if you withdraw 50K every month from debt fund, only 5K (growth) would be taxable or 60K per annum would be taxable - well below taxable limit!

    Reply
  9. Rajendra Dixit

    Pattabiraman Murari - You would be surprised but actually tax outgo from FD would be much higher than from debt fund. Let me take an example for which I would assume 10% returns from both FD and debt fund (for simplicity I am taking 10%). Another assumption - there is no other income source. Lets say you require to generate 50K per month or 6 lakhs PM income is required so you would require 60 lakh corpus. Now income generated from FD would be added to your income and taxed at your rate of tax. So total of 3.5 lakhs would be taxable income from FD. As against that if you withdraw 50K every month from debt fund, only 5K (growth) would be taxable or 60K per annum would be taxable - well below taxable limit!

    Reply

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