Calculating Insurance Needs

How does one calculate these parameters? If choosing the right insurance for you is hard, imagine having to calculate how much you need to buy!

There are 2 ways to calculate life insurance cover requirements: Expense Protection and Human Life Value approach. While the former considers your expenses, the latter considers your future income. Human Life Value is the economic value of an individual; the present value of all his future income. Setting aside the part of income one spends on himself, the protection required through Human Life Value calculates today’s value of his income for the years till his retirement. Expense protection, on the other hand, calculates the corpus required to take care of the family’s future expenses and goals. Inflation diminishes the value of money and hence expenses need to be adjusted to inflation for calculation of protection required.

For what term do you need this cover? Ideally insurance must be taken to cover the working period in one’s life. You take insurance to protect your dependents from the loss of your income; using the same logic, you take insurance for the time that the dependents are being supported by your income. Hence, it is advisable to take insurance till one’s retirement. However, when insurance is taken for protecting and saving towards specific goals, then the tenure of the plan should match the years left for meeting the goal.

What type of products suit you? Choosing a product will depend on the specific need and the life stage one is in. What is the final product you will choose? When there are multiple choices that match the need, it is the affordability that makes the final choice. Most importantly, individuals must be educated. They must know that life insurance products for investment and savings are structured for the long term and meant for someone who is earning and whose earnings are supporting his/her dependant/dependants. We have seen clients who have 17 insurance policies. We have seen clients who bought insurance policies for their non-working mothers as a gift, not realizing that a non-working member of the household with no young children does not need to have insurance purchased in her name. Better to have bought insurance on the Father who is supporting the mother, so that she can get some financial help when he is no longer there.

To demonstrate the importance of adequate insurance and planning, we’ll take an example of a 35 year old married man with 2 children. He earns Rs. 5 lakhs per annum, spends Rs. 3 lakhs to run the household and is the only earning member in the family. He has an existing term plan with risk cover of Rs. 15 lakhs which he took when his second child was born. In March 2009 he invests Rs. 10,000 in a pension plan to make up the shortfall in the income tax deductions allowed for him. As far as he is concerned he is well insured and set for the future. Let’s see what happens if he were to die tomorrow. The family will receive Rs. 15 lakhs as claim settlement from the insurance company. Assuming that they invest the entire corpus in an FD at 10% interest per annum, their annual income would be Rs. 150,000. The shortfall in this case, to meet the household expenses, will be an additional Rs. 150,000 every year. To meet the shortfall, they will have to dig into the accumulated corpus, which in turn will diminish to nothing in just 7 years. What will happen to his family post that? Who will provide for his children’s education, marriage, his wife’s retired life and all such important aspects that should have been planned for? Let’s now assume that he survives till his retirement. Assuming his retirement age to be 60 years and the return on his pension investment of Rs. 10,000 per annum to be 8%, the accumulated corpus at his retirement would be Rs. 7.9 lakhs (the value of which today is Rs. 1.15 lakhs). Will that suffice to take care of him and his wife for their retired life?

Some points to consider:

• It is very important that you are adequately covered as inadequate cover is equal to No cover at all.
• Insurance planning is the first step towards financial planning and financial planning should be the first step towards purchasing insurance. To advise an individual on his insurance needs, it is important to get a holistic view of the present and the future.
• Insurance requirement must be reviewed every 2 years or when there is a change in the family scenario example: addition of dependents.
  
• The insurance requirement changes with every change in your life - income, expenses, life style, members, liabilities and assets.

Financial Planning and its role in selecting insurance: To be able to prescribe the best insurance products for an individual or family, a financial plan is necessary. An advisor needs an in-depth knowledge and understanding and proper prioritization of all aspects of the client’s life. The probable duration of life, amount of security needed, present and future needs / shortfalls and post retirement requirements are also essential pieces of information to be collected. Knowledge of the “markets” / mutual funds and economic climate coupled with comprehension and application of HLV (Human Life Value), Expense Protection, and Corpus requirements for retirement help in prescribing an effective solution. With the awareness of a need for proper financial planning on the rise, coupled with the plethora of insurance products available, it is imperative that a “consultant” now needs to upgrade his skills as a financial advisor.

Some gifts can be expensive this Diwali - Tax on gifts above Rs 50,000

People receiving gifts, in cash or kind, will have to pay tax, if the value exceeds Rs 50,000. Until now, income tax was levied only on cash gifts above this amount. However, a notification issued by the Central Board of Direct Taxes (CBDT) said the revised norms will come into effect from October 1, 2009. “Any such person who receives a gift of any such property on or after October 1, 2009, must pay income tax due on the value of the gift and disclose the taxable value of such property in the return of income for assessment year 2010-11 and subsequent years,” said the CBDT statement.

It is important to know the details of this tax liability to make sure that you are not caught on the wrong side of the law. Individuals receiving shares, gadgets, automobiles, jewelry, valuable artifacts or even property valued at over Rs 50,000 as gifts from non-relatives, will have to start paying tax from October 1, 2009.

It means that if you receive high value gifts then the value of these gifts will be added to your total income and the corresponding Income Tax will be deducted. These types of gifts will be considered as income from other sources from assessment year 2010-11 onwards. For example, if you received a car for a Rs. 6,00,000 from a friend, you will have to pay up to Rs. 1,80,000, if your income falls in the highest tax bracket of 30 per cent. In case a property has been sold at a nominal rate as a gift, the receiver will have to pay taxes on the difference between state government notified rate and the purchase price.

These changes were brought in to plug the loophole in section 56 according to which only cash gifts of more than Rs. 50,000 from non-relatives were taxed. You could have received gifts as shares or any other non-cash instrument and avoided paying tax. From October 1, 2009 this will not be possible.

However, gifts to relatives and gifts for a wedding are not taxed.

Here are some tax exempt categories to utilize gift tax provisions in your favor:

1. Any gift from relatives of any amount during the financial year is completely exempt from tax. For Income Tax department a relative means the following: (also depicted in the picture below)

a. Your spouse;

b. Your brothers and sisters and their spouses;

c. Your spouse’s brothers and sisters and their spouses;

d. Brother and sister of your parents and their spouses;

e. Any lineal ascendant (parents, grandparents, children, grandchildren) or descendants (children, grandchildren);

f. Any lineal ascendant (parents, grandparents, children, grandchildren) or descendant of your spouse (children, grandchildren)

2. The provision is applicable only to individuals and HUF (Hindu Undivided families) but if a gift is received by a trust or a society then it is tax exempt.

3. Gifts received from anybody for weddings are tax exempt.

4. Following other kinds of gifts are also exempt from the tax axe:

• Gift received under a Will or by way of inheritance;
• Gift received due to of death of the donor;
• Gift from any local authority;
• Gift from any fund or foundation or university or other educational institution or hospital or any trust or any institution referred to in Section 10(23C); and
• Gift from any trust or institution, which is registered as a public charitable trust or institution under Section 12AA.

Be careful while accepting expensive gifts this festive season. It may turn out to be expensive!

6 ways to the Perfect Vacation

Most of us look forward to our dream vacation. Some prefer exotic destinations like Bahamas, Miami, Maldives, others frequent their favourite hill station or beaches, while some of us just stay home, chill out and relax. An increasing trend is to take a packaged trip to Europe or an expensive cruise in Southeast Asia. Regardless of where you want to go, you can make it the holiday you want it to be – without burning a hole in your pocket – by paying attention to the following simple tips:

Plan in advance:

Keep a little money aside every month rather than tapping into your savings to pay for the whole vacation at once. Start building your vacation fund about 4-6 months in advance. Availability of these funds makes your life easier by softening the financial blow. Planning in advance also means you are more likely to find bargains on hotels and travel and at the same times it’s much easier to get the vacation time sanctioned by your boss.

Setup a budget

Calculate how much money you need to cover all of your basic expenses like food, accommodation, and transportation and then allocate some extra cash for souvenirs and unexpected expenses. It's worthwhile to do some research about the cost of vacationing at a place.

Sticking to your budget is much more important than creating one. Once you get to your destination, you have to stay focused as you come across numerous temptations to splurge.

Credit card: Your friend in need

Let’s face it, credit cards are the biggest culprits when it comes to overspending but at the same time they are great saviours in times of need. They can be your best friends and also the worst foes.

Don’t take your cards with the intention of using. If possible avoid keeping it in your wallet, keep it secure in the hotel room or safe. It serves two purpose: First, you won't be tempted to buy more gifts and souvenirs to take home with you; and second, it ensures that you'll have backup funds in the event of a real emergency – such as if your wallet gets stolen.

Internet: Your Best Friend

Searching the web goes a long way in grabbing great deals on hotels and transportations or even packaged tours. Use the internet to look for recommendations and feedback from other travellers. There are numerous websites which offer ratings and reviews for destinations, hotels and sightseeing. You will be less fearful of trying something new and be better prepared. You can also contact the person and get more details about your dream destination. For example, a friend of mine called a hotel directly and received a 20% discount based on a user’s experience posted on a hotel review site.

For Air travel, compare prices to find the best deal. Booking 3-4 weeks in advance can save you up to 40% in some cases.

Keep it simple

The best way to be in control of your expenditure is to pay in advance. Pay your hotel and travel bill in advance rather than paying in cash when you get there. If you are using the services of a tour operator, read the fine print and see what exactly you have paid for. It will help you decide how much money to carry for extra expenses.

Vacation on a shoestring budget

If you want to have a vacation on a shoestring budget and still have a ball, camping is the way to go for the adventurous types. It eliminates 2 of your biggest expenses viz. hotels and travel. Look out for a forest/national park in your state or close to your city and find out more about it. Most of these destinations offer budget cottages. It can be cost effective and lots of fun especially if you are with a bunch of like-minded friends.

By following these simple yet effective tips you can get the most out of your vacation and not be bogged down by financial worries. Go out and enjoy!

Top Financial Mistakes

1. Lack of goals

“Most people don't plan to fail; they just fail to plan”. A good percentage of people are still not aware of what is financial planning and how to go about it. In simple words, financial planning is taking a disciplined approach to achieving your pre-determined financial goals. A good financial plan is based on strong goals.

Well-articulated goals with a detailed break-up into longterm, midterm and short term, specific steps on how to achieve them and checking the progress periodically are basic ingredients of financial planning. As you can see it all starts with a goal.

2. Lack of life cover

Living without life insurance is just like "flying without a net". A financial plan is incomplete without adequate life cover. One major goal of a financial plan is to maintain the life style of your family whether you are with them or not.

A common mistake we make is buying life insurance policies such as endowment plans or money back to save tax, also hoping to reap returns. Remember, returns from such policies are much less compared to traditional investment products such as stocks, mutual funds, gold or real estate. So why not separate investment and insurance completely? Most salesmen will not give you this advice because the commission in plain vanilla term policies is the lowest.

Protect yourself with an inexpensive term policy providing sufficient life cover. The thumb rule for your life cover is your annual income multiplied by 10. You can add family floater mediclaim or health insurance policies for self and family members. It’s a way of making sure that your family will continue to enjoy the current life standard.

3. Lack of investments

Start saving as early as possible. Generally, a person should start saving and investing money from the day of getting first salary. By starting your financial plan at the earliest, you are allowing your money to grow by the sheer power of compounding.

Don’t be over-enthusiastic about it either. Develop a regular and disciplined investment approach. Select a few good equity funds and do a SIP (Systematic Investment Plan). Increase the investment amount as your income increases. Don’t wait for a lump sum amount to be accumulated to invest and don’t try to time the market.

4. Too much of loans and debt

“Don't stretch yourself too much with a mortgage. Buy within your means. It’s not worth the sleepless nights”. It’s always advisable to resist the temptation and control unnecessary expenses. It includes loans, mortgages and credit card expenditure.

House loan and car loan may be necessary but do some analysis about how much you really need and what can you comfortably be able to pay back. Keep a tight leash on personal loans and credit card debt. They can be a drain on your finances as the interest rates are much higher. You must have a plan to reduce the loan and pay off the debt gradually.

5. Only debt/fixed income instruments

Putting your entire investment amount into the debt instrument is like settling for a bonsai instead of a huge teak wood tree which you could have. It's good to be safe but too much of safety will not make your money grow. There are many among us who keep their money in FDs, PPF, insurance policies, National saving certificates etc. It’s good to have them but they should not have all your money. You must have a healthy mix of equity and debt in your portfolio. Equity gives you growth and debt gives safety with peace of mind.

6. Over-indulgence in stocks

By watching too much of business news channel and reading business journals we start believing that we know all about stocks and the way companies work. Listening to equity analysts gives us more encouragement. We think we can beat the market. But the truth is most people fail to make money at the stock market and end up wasting their precious time and wealth. Sit with a certified Financial Planner and chalk out a long term plan for yourself. Remember “slow and steady wins the race”.

7. Owning too many products

“Wide diversification is only required when investors do not understand what they are doing”. The unavoidable risk from over diversification clearly articulated in this powerful quote by Warren Buffett.

The right portfolio should be built by optimum allocation into different asset classes. A good financial planner should be able to tell you the right proportion as per your profile. Within a particular asset class it’s better to do thorough research and put your money in a few select products. For example if you are investing in Mutual funds then buying too many of them is not advisable. Similarly if you are an investor in stock market it’s advisable to pick the right stocks and stick with them.

We keep adding more products to the portfolio because we fall for what the salesmen and advertisements tell us. Do your own research or consult a certified financial planner for such decisions. It’s important to own the right ones and not too many.

Investing in Gold and Gold ETFs

Investing in Gold provides a sense of security as it is tangible unlike many other financial products which are intangible. Gold prices are purely determined by supply and demand and less likely to fluctuate wildly. There are many time tested advantages of having gold as an investment:

• Safety: In volatile and uncertain times (as seen recently due to recession) Gold provides safe haven as there is no default risk. Gold has its own intrinsic value.
• Brings diversification and stability to a portfolio: the forces acting on gold are different from those acting on other financial assets. Most of the time it is negatively correlated to stocks and bonds.
• Highly liquid and portable: Gold can easily be converted to cash and vice versa, prices are internationally determined.
• Tool against inflation: Irrespective of market cycles the purchasing power of Gold stays intact over a long period of time. It’s better to keep your cash in the form of gold.
• Less regulatory intervention: you don’t have elaborate disclosure norms for gold as it is for many other asset classes. Gold can be a very private investment.

Diwali is an auspicious time for buying Gold and it should be used wisely to invest. But there are many ways to invest and it can be a daunting task. Let us see the pros and cons of the options you have:

Jewellery:It is one of the oldest forms of investment which also has some amount of pride and honor attached in Indian families. It is something you can use and enjoy but at the same time it keeps appreciating in value. But the price of jewelry is usually marked by anywhere between 20 to 200% depending on the complexity of design. This makes it unattractive as an investment.

Gold bars and coins: Gold coins and bars are increasingly becoming popular not only as investments but also as gifts. But they have to be physically stored which can be a security nightmare. You might have to incur extra cost in renting a bank locker or insuring your possession. Moreover you have to be careful about adulterated and fake ones. There can be a substantial difference between buy and sell rate of gold coins and bars.

Electronically traded Funds: More popularly known as ETFs are open-ended mutual fund schemes that invest the money collected from investors in standard gold bullion (0.995 purity). The investor's holding is denoted in units, which is listed on the stock exchange just like a share. It is expressed as NAV (Net Asset Value) which represents the price of one unit (equivalent to 1 gram gold) on that particular day.

These are many advantages of ETFs vis-à-vis physical gold when seen from an investment perspective:

a. No need to worry about the security and storage

b. No need to worry about quality of the gold

c. No need to worry about resale as the exchange provides comfortable liquidity (just like shares)

d. No making charges

e. You can invest very small amount of money (minimum 1 unit) which is not possible in case of jewelry and coins/bars.

f. No wealth tax. Long Term capital gains just after 1 year whereas it is 3 years in case of physical gold.

ETF is a tax smart investment as well.

5 Ways to make your Children Financially smart

1. Make your child understand the difference between needs and luxuries

Children need to understand that they can still go on without cool gadgets, designer accessories but not without essentials like ‘Roti, Kapda aur Makaan’. Hence they have to prioritise accordingly. Sit with your child and help him prioritize according to needs and luxury. Once this concept is clear your child will transform into a better decision maker.

2. Set a goal for your child and help him achieve this through a budget

Goal setting is easy enough in today’s materialistic word. Sports equipment, a gadget or an item of clothing, motivate your child by setting a goal and encourage him to earn this through household and other chores. Make him draw up a budget from what he earns every week and show him how to save from this. Definitely reward him with something extra (besides his goal) the first couple of times, so that he is geared up and excited about the next goal and starts planning – the secret mantra to financial happiness. This will also help your child become competitive in life and be focussed on goals.

3. Understand your child’s money personality

He could be a spender by nature. If so, you can guide him early on to curb this by encouraging him to not keep too much cash and ensuring that it is not easily accessible. If he keeps borrowing money from his friends then this could be a warning signal. Later on he could get into a debt trap. You can counsel him and also understand the source of his needs.

4. Involve your child in day to day financial activities

Entrust him with the responsibilities of paying bills i.e. going to the collection centres and paying the bills through cash or dropping a cheque. If he is not old enough than at least take him along when you are doing this exercise. It is a good way for him to learn that life is not just an ATM machine, you got to pay as well!

5. Open a bank account for your child and make him operate it

Buy your kid a piggy bank when he/she is very small and encourage saving for achieving his little goals. Open a bank account when he grows up. This the best way for him to understand how money grows, what interest is and how financial institution like banks work. You should opt for a joint account as it will give you the ability to oversee what your kid is doing. Step in whenever you think that he/she is going off track and try to rectify the situation by helping him with basic financial concepts mentioned above.

Use this Children’s Day as an opportunity to gift financial literacy to your child. In the long run this will be more valuable than anything else.