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Retirement means the end of earning period for many, unless one chooses to work as a consultant. For retirees, making the best use of their retirement corpus that would help keep tax liability at bay and provide a regular stream of income is of prime importance. Building a retirement portfolio with a mix of fixed income and market-linked investments remains a big challenge for many retirees.
The challenge is not to outlive the retirement funds – one retires at 58 or 60, while the life expectancy could be 80.
Here are few investment options for the retired to provide for their monthly household expenses. The idea is to build a retiree portfolio with a mix of these products.
Senior Citizens’ Saving Scheme (SCSS)
Probably the first choice of most retirees, the Senior Citizens’ Saving Scheme (SCSS) is a must-have in their investment portfolios. As the name suggests, the scheme is available only to senior citizens or early retirees. SCSS can be availed from a post office or a bank by anyone above 60. Early retirees can invest in SCSS, provided they do so within three months of receiving their retirement funds. SCSS has a five-year tenure, which can be further extended by three years once the scheme matures.
Currently, the interest rate in SCSS is 8.6 per cent per annum, payable quarterly and fully taxable. The rates are set each quarter and linked to the G-sec rates with a spread of 100 basis points. Once invested, the rates remain fixed for the entire tenure. Currently, SCSS offers the highest post-tax returns among all comparable fixed income taxable products. The upper investment limit is Rs 15 lakh and one may open more than one account. The capital invested and the interest payout, which is assured, has sovereign guarantee. What’s more, investment in SCSS is eligible for tax benefits under Section 80C and the scheme also allows premature withdrawals.
Post Office Monthly Income Scheme (POMIS) Account
POMIS is a five-year investment with a maximum cap of Rs 9 lakh under joint ownership and Rs 4.5 lakh under single ownership. The interest rate is set each quarter and is currently at 7.8 per cent per annum, payable monthly. The investment in POMIS doesn’t qualify for any tax benefit and the interest is fully taxable.
Instead of going to the post office each month, the interest can be directly credited to the savings account of the same post office. Also, one may provide the mandate to automatically transfer the interest from the savings account into a recurring deposit in the same post office.
Bank fixed deposits (FDs)
A bank fixed deposits (FD) is another popular choice with the retirees. The safety and fixed returns go well with the retirees, and the ease of operation makes it a reliable avenue. However, interest rate over the last few years has been falling. Currently, it stands at around 7.25 per cent per annum for tenures ranging from 1-10 years. Senior citizens get an extra 0.25-0.5 per cent per annum, depending on the bank. Few banks offer around 7.75 per cent to seniors on deposits with longer tenure.
Unlike SCSS and POMIS, bank deposits provide flexibility in terms of tenure. Therefore, instead of locking funds for a particular duration, an investor may spread the amount across different maturities through ‘laddering’. It not only provides liquidity to funds, but also manages the ‘re-investment risk’. When the shortest-term FD matures, renew it for the longest duration and continue the process as and when various FDs get matured. While doing so, ensure that your regular income need is met, and deposits are spread across various maturities and institutions.
For those looking to save tax, the five-year tax saving bank FD could be a better option. The investment made here qualifies for Section 80C tax benefit. However, such a deposit will have a lock-in of five years and early withdrawal is not possible. Even though the interest income is taxable, there is a set-off by the amount of tax saved at least in the year of investment. Most banks offer a rate which is slightly lower than the non-tax saver deposit rates. So choose carefully, if you want to go for them.
Mutual funds (MFs)
When one retires and there is a likelihood of the non-earning period extending for another two decades or more, then investing a portion of the retirement funds in equity-backed products assumes importance. Remember, retirement income (through interest, dividends, etc.) will be subject to inflation even during the retired years. Studies have shown that equities deliver higher inflation-adjusted returns than other assets.
Depending on the risk profile, one may allocate a certain percentage into equity mutual funds (MFs) with further diversification across large-cap and balanced funds with some exposure even in monthly income plans (MIPs). Retirees would be advised to stay away from thematic and sectoral funds, including mid- and small-caps. The idea is to generate stable returns rather than focus on high but volatile returns.
Debt MFs can also be a part of a retiree’s portfolio. Taxation of debt funds makes it a better choice over bank deposits, especially for those in the highest tax bracket. While interest on bank deposits is fully taxable as per the tax bracket (30.9 per cent for highest slab), income from debt funds gets taxed at 20 per cent after indexation, if held for three years or more irrespective of the tax bracket.
A retiree can consider keeping a significant portion in debt funds also because of its easy liquidity.
Tax-free bonds, although not currently available in the primary market, can also feature in a retiree’s portfolio. They are issued primarily by government-backed institutions such as Indian Railway Finance Corporation Ltd (IRFC), Power Finance Corporation Ltd (PFC), National Highways Authority of India (NHAI), Housing and Urban Development Corporation Ltd (HUDCO), Rural Electrification Corporation Ltd (REC), NTPC Ltd and Indian Renewable Energy Development Agency, and most carry the highest safety ratings. One may, however, buy and sell them on stock exchanges as they are listed securities.
Retirees should keep a note of a few things before investing in tax-free bonds. One, they are long-term investments and mature after 10, 15, 20 years. Invest in them only if you are sure that you will not require the funds for such a long period. Second, the interest is tax-free therefore there is no Tax Deducted at Source (TDS) too. In the last two tax-free bond issues the effective yield, especially for high tax-bracket investors, compared favourably with taxable investment alternatives available at the same time. Third, liquidity is low in tax-free bonds. Usually, they are listed on stock exchanges to provide an exit route to investors but price and volume (quoted at exchanges) may play a spoilsport while off-loading them. Last, they usually offer annual and not monthly interest payouts hence may not meet a retiree’s regular income requirement.
For example, in a declining interest rate scenario, a tax-free bond (face value Rs 1,000) with a coupon rate of 8.3 per cent tax free return may be available in a stock exchange at a price of Rs 1,217, with a yield of about 6.4 per cent, maturing in 2027 if the investor holds it till maturity. Remember, the interest payouts are at the coupon rate of the bond, i.e., an investor gets 8.3 per cent tax free income on his investment and the actual return will be 6.4 per cent if the bonds are held till maturity.
Retirees could also consider the immediate annuity schemes of life insurance companies. The pension or the annuity is currently around 5-6 per cent per annum and is entirely taxable. There is, however, no provision of return of capital to the investor, i.e., the corpus or the amount used to purchase annuity is non-returnable. There are about 7-10 different pension options, including pension for lifetime for self, after death to spouse and post that the return of corpus to heirs. The corpus is not returned to the investor under any pension option. The immediate annuity may not suit an investor who is capable of selecting and building his own portfolio.
So it is better to diversify across different investments rather than invest in this scheme if you have the wherewithal to manage your own portfolio. This is also advisable as the returns offered on these immediate annuities are currently on the low side.