Updates on Direct Tax Code for 2011 by Pranab Mukherjee

Earlier in 2009, Indian Government proposed a new tax code for year 2011. In this proposed tax code, government indicated radical tax reforms to simplify taxation. To make it robust and accepted by citizens, this draft was open for public suggestions. Now on June 15th 2010, government released its revised version of proposed Direct Tax Code (DTC).

The major change that came is that tax on provident fund and life insurance products are to be treated on Exempt-Exempt-Exempt (EEE) basis instead of EET (Exempt-Exempt-Tax). Another major decision is for ULIPs. From the year 2011, new ULIPs will not have EEE benefit but existing ULIPs will continue to get EEE benefit. Further, there will be no capital gains on savings schemes.

Tax Saving Mutual Funds

Mutual Funds are considered to be the best investment option with moderate risk. Though, Mutual Funds are linked with market, but they are managed by professional fund managers and fund-houses. You also get the option to invest your money in balanced or pure-equity funds. You can get really good returns from MFs, if you invest for a minimum period of 3-5 years.

As Mutual funds are so popular, special funds were introduced for the investors to save income tax. These funds are called as tax-saving mutual funds and popularly known as ELSS (Equity Linked Savings Scheme). ELSS has a lock-in period of three years, so when you invest in these funds, your money will be locked for three years. But, you can expect better returns after 3-5 years than other traditional savings schemes and you also get the tax rebate under section 80C.

But financial year of 2010 – 2011 may be the last year for you to invest in tax-saving mutual funds in India. As per the upcoming tax-code for the financial year of 2011-2012, Pranab Mukherjee, Finance Minister of India has proposed a new tax code for the financial year 2011. As per the new tax code, there will be no income tax benefits under section 80C for ELSS, Tax-Saving Fixed Deposits, and NSCs.

If the current proposal gets passed in the assembly next year, you will not be able to avail tax-benefits for ELSS from the financial year of 2011 onwards. So, it may be the last year for you to put some decent amount of money in tax-saving mutual funds. The decision of abolishing ELSS from 80C can definitely harm mutual fund industry as a major part of investment goes in tax-saving funds. Best feature of ELSS is its three years lock-in period, so you can easily withdraw your complete amount after three years of time and avail tax-benefits. Only alternative that will be left after new tax-code implementation would be ULIP with moderate risk and to grow your money. Though, as per recent announcement from SEBI, no new ULIP plans will be offered to users. Well, nothing much can be commented as of now as things are not transparent, but it might be a step towards direct tax code implementation and they might be planning to abolish even ULIP from 80C indirectly.

So, if you want liquidity of money along with tax-saving, tax-saving mutual funds can be the best bet for the financial year of 2010-2011.

Update:
As an update, direct tax code has been delayed by one year, i.e. 2012. So now you can invest in Tax Saving Mutual Funds (ELSS) in 2011 also and avail tax benefits under sec 80C. Click on the link to find the updates of new tax code for 2012.

ULIPs vs MFs

To invest your money in ULIPs (Unit-Linked Insurance Plans) or MFs (Mutual Funds), and to chose in between them, there are many factors that you have to look upon.

Firstly you must know for how many years you want to put your money, means for short-term, mid-term or long-term, same case as with equity market but here you do not have to track it daily or weekly. Once in a month or two is more than enough.
And secondly whether you want to have life-insurance coverage with your plan or not.

Major factor here is time-period, as ULIPs are beneficial only if you want to invest for more than 5-10 years. In case of ULIPs initial years charges are too high. So if you have time horizon for more than 10 years and also want some life-insurance benefit then you can go for ULIP plan. And if you basically want to invest money for some less time period then you should go for MFs. Again in MFs there are several plans available to you like complete equity, and some with combination of debt and equity, so you can invest and take plan as per your risk appetite.

Also if you do not want any life coverage then MF is always a better option. And you can go for separate life-insurance policy which is pure life-insurance policy (term-insurance plan) with no money-back. If you want to go for pure life-insurance, then you can take policy for any amount, and it depends on person to person how much that person wants to give to his/her dependents in case of any mishappen.

Insurance companies themselves admit that if your investment horizon is anything less than 7 years, don't even consider a ULIP. This is because, the charge structure in a ULIP is vastly different from a mutual fund. In the first year, a large chunk of the charges are recovered from investors. It could be as high as 40 per cent, in terms of some annual charges, fund management charges and some other charges as well.

ULIP tend to be expensive propositions (in comparison with mutual funds) during the initial years. However, over longer time horizons, the expenses balance out and ULIPs work out to be cheaper as compared to mutual funds. However, even if the lower expenses of a ULIP vis-à-vis that of a mutual fund scheme were to be considered, the latter would still surface as the better option.

You can make adjustments to your mutual fund portfolio. If you believe you have made a wrong investment decision, you can redeem your investment in a particular mutual fund and invest in another one. Such adjustments are not entirely feasible in a ULIP. If you want to switch in a better ULIP plan of another company, then again you have to start afresh, means again you have to pay those heavy initial charges.

Switch over between ULIPs of different insurance companies is not possible in case their performances are below par. Worse, most ULIPs do not even disclose details about their fund management and their portfolio to the investors.

A simple mutual fund or even a few blue-chip stocks would get you much higher returns and keep your portfolio simple to understand.

So if you want to get the benefits of long term investment and risk cover in one single product, ULIP is the product for you. So it is not an issue, of whether a mutual fund is better or a ULIP. It is about your need. Both can co-exist in your basket of needs. So identify your needs with a financial planner and then pick the product suitable for you. In a ULIP, your premium is divided into your risk cover and your investment. That means, out of the total premium that you pay, a certain percentage will be deducted as risk cover to provide for your insurance and the balance will be invested in a fund. Your risk cover charge will increase every year with your age. As a result the investment allocation will reduce.

Check out various other low risk investment options to invest your money.