Whats the Right ROTH Conversion amount?

When it comes to retirement accounts in the US, there is no dearth of choices. They come in all flavors and each one brings its own merits and restrictions. If you are one of those investors, who have an IRA account in addition to a 401k account, you may have heard of discussions pertaining to converting your IRA to a Roth IRA. In this blog, we shall examine these two types of account and analyze whether it is advantageous to make the conversion from one type to another.

Rationale for Roth conversion

Individual Retirement Accounts [IRA], also known are Traditional IRAs are basically retirement savings accounts. Those with annual incomes up to $198k [MAGI] can contribute $6000/- per annum into their IRA accounts and get a tax deduction for their contributions. As these are paid with pre-tax dollars, all future earnings and withdrawals are taxed. If you are eligible to make a ROTH IRA contribution, these are made with post-tax dollars and hence future earnings and withdrawals are NOT taxed. Now, we shall see if you should convert your traditional IRA to a Roth IRA!

Generally tax saving on future earnings & incomes is touted as the primary reason for an IRA to Roth conversion. However, one needs to objectively assess the move in light of various aspects covered below:

  1. Let us say, presently you are in the 24% tax bracket ($171-$326k income for 2020). Do you expect to be in a higher tax bracket when you retire?
  2. Is the current Traditional IRA corpus solely from “Deductible IRA”? Or did you make any “Non-deductible” contributions?
  3. By converting even 20% of IRA funds to Roth, your income could jump from a lower 24% tax slab to a higher 32% slab. And that could significantly impact your tax liability – do you have the cash in hand to pay for this additional tax?
  4. Or do you have sufficient losses from other heads of income(s) to offset the tax liability that may arise from this Roth conversion?
  5. Is the market level right for you to convert a part of your IRA to Roth or should you wait for a deep correction in order to reap the disproportionate taxes incurred now as rewards / returns in future?
  6. Would you have other sources of income when you turn 70.5, that you do not need to withdraw the minimum sum from IRA under the RMD (Required Minimum Distribution) rule?

Once you have the answer to these questions, then it makes sense to do the math and see how much you stand to gain in taxes payable now (vs) taxes deferred to future. The other incentive to convert is to overcome a constraint introduced by the SECURE Act – whereby upon demise of the account holder (wef 1.Jan.2020), legal heirs (except surviving spouse) are mandated to withdraw inheriting IRA account balances in 10 years & pay higher taxes along with their then future income(s).

Important points to consider in your DECISION

  • It makes sense to convert only to the extent you remain within your current tax bracket
  • It would make for smart investing to convert amounts in excess of your retirement corpus
  • Any sum that you set aside in IRA to bequeath would largely benefit from the conversion

Do the Math with your financial advisor and understand the right amount to convert. It would help you optimize tax outgo NOW (vs) taxes payable from ages 59.5 or 70.5 depending on your annuity withdrawal age from IRA, happy planning!

Also read how good are 401k Target Year Retirement Funds!

Budget 2021 – Personal Finances

Overall this budget has not made major changes to personal taxation. However, few areas to take note are detailed below:

1. Wef 1.Apr.21, interest on EPF + VPF contributions in excess of Rs.2.5Lacs will be charged as interest income similar to FDs – further details are awaited as to whether only the first year’s interest is taxable or future interest that accrues/compounds from this excess contribution would also be taxable (in which case it could become an accounting nightmare for EPF).

Next step – A neater solution would be to prevent or cap employees’ contribution at Rs.2.5L in EPF/VPF each. Similar to government’s move last year that set an aggregate limit of Rs.7.5Lacs for employer contributions to EPF, National Pension System (NPS) and superannuation fund.

Rationale – About 1.1% of EPF account holders who also happen to be very high income earners are contributing lakhs and crores of their income(s) into their EPF & VPF accounts, to earn the highest 8.5% tax free interest. According to the government, this arbitrage is not fair to low income employees who are able to contribute only Rs.20833 p.m towards their retirement. Hence this tax measure does not impact 99% of EPF contributors.

2. All equity/stock market capital gains, interest & dividend income will be auto-populated in ITR forms for ease of tax compliance. The tax department collects data about all financial, real estate and gold investments made by individuals based on PAN numbers. This info would now be pre-filled in the assessees’ income tax returns to help with better tax compliance.

Rationale – A simple and effective way to curb under-reporting & non-reporting by use of technology. It also widens the tax base beyond the salaried class – whether they are from informal sector, self-employed, business owners or even rich agriculturalists.

3. ULIPs are now brought at par with equity mutual funds with regards to taxation, which was a long pending measure. Maturity proceeds from policies with premiums in excess of Rs.2.5Lacs will now be taxed as equity mutual funds (wef 1.Feb.21). This measure plugs the tax arbritrage of ULIPs and prevents mis-selling.

4. For pensioners above 75years of age, there is no need to file ITR – but tax will be deducted by bank. Need to see if the same would happen to all pensioners regardless of age. While this helps seniors from having to file their income tax returns, in case they employ any tax saving instruments under section 80C, they may still have to get help to file their returns and claim refunds.

The EPF tax proposal needs to be watched closely for amendments (or rollback) by 31.Mar.2021.

The Great Gold Rush 2020

Gold has been galloping and has returned 54% in INR absolute returns since jan/2019 and 38% since jan/2020. In fact it seems to be in a race with the stock market and has got a wide spectrum of investors puzzled and interested at the same time.

Gold comes with a long investing history and is often seen as a safe asset class in times of crisis. While trade war in 2019 created some to shift their investing to gold, the stock market plunge due to covid-19 caused gold price to spiral up 48% from $1281 (01/2019) to $1894 (01/2021).

Why the great rush?
Traditionally gold has an inverse correlation with the stock markets. When stocks are down, gold rises and vice versa. Gold is also known to have an inverse relationship with the USD. As gold itself is denominated and traded in USD, when USD strengthens, gold falls and vice versa.

However, since the GFC (Great Financial Crisis 2009) and the invention of money printing, the correlation between stocks and gold stands broken. This is due to cheap liquidity made available in plenty by the Fed ($7.24Tn) and other developed market central banks over the last decade (2010-2020).

Basic economics tells us that when demand rises without rise in supply, it results in a price rise. As more and more cheap cash chases fewer stocks in emerging market equities, it pushes up their prices and makes their valuations extremely high (Nifty P/E 38).

Domestically, whenever real interest rates turn negative, savers are disincentivized to save in cash assets such as fixed deposits and move to capital assets like stocks, or physical assets like gold and property. HNIs on the other hand move to exotic assets such as angel investing and cryptocurrencies, which explains the bubble in startups and bitcoins.

Did you miss out?
From a personal finance perspective, gold is just one among many types of assets held in an individual’s portfolio. It is quite similar to a plot of land in that it does not generate any passive income and may take long tenure to appreciate in value. Its price may rise/fall in the interim years depending on various factors such as real returns from other asset classes, political instability, social unrest, trade/currency/civil war and more importantly policies of central bankers.

Prior to 2013, long term return from gold over 20 years in rupee terms was 6% barely meeting inflation. Only post QE, return from gold is in the range of 10-12% p.a, very similar to returns from equity markets. And its outlook for 2021 is at $1900-$2300/oz. As long as you have a well diversified portfolio in different asset types, it would help you ride the upside and tide the downside – so that you could grow your portfolio and fulfill your personal financial goals.

Also read: Sovereign Gold Bonds

How to make your next million dollars?

Well, there are a number of ways to make them, especially with today’s startup magic wand. However, if you are someone in your 40s and are staring at a number of responsibilities and liabilities, there is a less-adrenaline, more-meditative way to attain your (next) million dollars, here’s how:

Right place at right time?
We believe some people are lucky to be at the right place at the right time to get to their million dollars in a short span. For those who are not in that group, did you miss out something? Not at all, you only need the right strategy and guidance to get to your million.

Time or Money!?
If you do not have a lot of money today, but do have at least 10 years in time, then you are still at the right place at the right time. Time is equal if not more powerful than money to help you attain your financial goals. If you are able to invest $5000 p.m for the next 10 years, without the adrenaline rush, you could get to your million dollars. Even better, if you have 15 years time, all you need is only $3000 p.m to get to the same goal.

If you thought you needed more money to make your first or next million, think again. Start early, invest right and make your million by keeping calm – the power action on wall street is only for punters, (future) millionaires keep cool, begin their investment planning early and make a million dollars with no sweat!

How good are “401k Target Retirement Funds”?

Target Retirement Funds are popular retirement vehicles used by a good majority of the working class. They make regular pre-tax monthly contribution to a work related retirement savings plan like 401k or IRA. Their employer(s) too contribute to the same savings plan – aka defined contribution pension account.

These target retirement funds are conveniently pre-packaged to match the retirement year(s) of those employed, making it easier for people to subscribe to them. Lets say there is a Target Retirement Fund 2040 – if someone plans to retire in 2040, they may choose this fund in their 401k account. Monthly contributions by both employee & employer grow in this target retirement fund until they retire in 2040. Amount accumulated in such account may be withdrawn when one reaches 59.5 years of age.

True to their label?
While the above strategy saves time & effort, data shows such target retirement funds yield sub-optimal returns both in the short and long term. The reasons are primarily two-fold:
(i) Typical allocation of these funds is in 4 categories – US Equity, Emerging Markets Equity, Property/REITs in US & Debt/Treasury funds. While the allocation looks balanced, there are hidden headwinds here that dampen returns.

For example, while emerging markets may make headline news about huge returns, due to the appreciation of USD (vs) EM currencies, net dollar returns might still be dismal. Similarly, returns from property & bond funds could pull down the portfolio returns when compared to average equity market returns.

Besides, some of these funds are designed to invest in other funds and so their performance solely depends on the performance of such embedded funds.

(ii) Secondly, these funds follow an automatic “re-balancing” strategy – which annually shifts a pre-determined proportion of money held in equity to debt as one approaches retirement. Such robotic re-balancing fails to fully take into account the individual’s risk propensity, investment in assets other than 401k and the actual retirement income needs during the withdrawal phase.

What should you do?
It is important to evaluate all the funds available in one’s 401k/IRA and choose the right funds early on. Doing this could help make a big difference in returns (minimum 2x excess returns) even over an investment horizon of 10 years!

How to Tide over Covid?

Most of us are experiencing a pay cut or job loss or secondary income loss of some sort. There is absolutely no one that is not affected by covid economically and financially. Given the forewarning from medical experts that this virus is going to stay in the system for the next 2-3 years, how do we tide over the financial impact caused by this virus?

  1. Emergency fund
    The 3 month or 6 month emergency funds we held would now dry up fast, given the timing of this virus – yes, beginning of an academic year. Annual or term/semester fees of schools & colleges become due from May and hence they deplete any emergency reserves we hold.
  2. Interest from Bank FD
    In case you have been saving diligently over your working years and say have Rs.50 Lacs in bank FDs, you might take refuge about the sizeable corpus. However, with sub-6% interest rates today, you might only receive close to Rs.3L interest p.a, which is not sufficient to meet your liabilities.
  3. Apportion money for expenses
    Another strategy most people would consider to diffuse the situation is to set aside the entire expenses for next 3-4 years. But by doing so, at least half of the Rs.50L savings gets depleted.
  4. Rework the Math
    If you desire to receive Rs.6L income p.a / Rs.50k p.m, then you would need at least Rs.1 crore in bank FD. Not many people would be in such state of luxury to hold Rs.1 Crore in a bank FD.

What then is a solution to make up for the temporary loss of income/job?
Build a PASSIVE income source via a customized portfolio with a mix of financial assets.
Consider you have Rs.50Lacs that you invest in a customized portfolio (PF). This PF could pay you Rs.50k p.m / Rs.6L p.a. You could also set it up to pay you an inflation-adjusted income year over year. Your cumulative withdrawals add up to Rs.25.47 Lacs – this could have left you with a balance of only Rs.25 Lacs. But notice money in this PF grows every day and as a result it replenishes your PF balance by another Rs.15Lacs. Thus, at the end of 4 years, your PF balance is Rs.40 Lacs.

The above illustration uses a conservative portfolio. In case you wish to bring the portfolio back to the levels of initial investment, even that is achievable with some deft allocation – Are you ready to explore the Power of Portfolios?

Attention NRIs – Your Financial Checklist!

There are over 3 crore NRIs (Non-Resident Indians) abroad. Middle east has the most number of NRIs at 1 crore, followed by US-Canada at 45 lacs & UK at 18 lacs. The wealth of India’s NRI population is estimated at $1 Trillion (Rs.73 Lac crores), which is 40% of India’s GDP.

Focus areas

When an Indian leaves his/her homeland and stays abroad for more than 182 days in a year, he/she becomes a Non-Resident Indian (NRI). The NRIs have been given special economic status and they enjoy certain benefits but are also restricted from availing others. There are several aspects of finance that NRIs need to focus when investing their earnings in India. This is in addition to dealing with earnings, investments & tax in their country of residence, making it complex for NRIs to deal with two sets of systems & rules.
1. Earnings All incomes earned outside India by an NRI/OCI (Overseas Citizen of India) are neither required to be reported nor taxable in India. But all incomes earned in India by an NRI/OCI, are taxable in India. Such incomes include rents, capital gains from sale of property, plot of land, gold, shares, mutual funds etc and interest income from fixed deposits.
2. Banking With respect to bank accounts, the main difference for NRIs is the type of accounts held, below rules apply.
a. NRIs holding resident bank accounts (single or primary holder) -Not allowed, re-designate to NRO account
b. NRIs joint holding resident savings account (but not as a primary a/c holder)
-RBI permits close relative NRIs to be joint holders in resident savings account only on a “former or survivor” basis. Such NRI close relatives are however not eligible to operate the account during the life time of the resident account holder. In this case, aadhar of NRI is not mandatory.
c. Both NRO & NRE accounts are exempted from linking with Aadhar
3. Investing NRIs/OCIs may invest in almost all assets at par with resident Indians except in agricultural land. Typically NRIs make an investment by moving money from abroad to India, a process called remittance. All non-US based NRIs are free to invest in most financial products in India. However, the avenues for investing in capital market products differs for US based NRIs.
4. Insurance Some NRIs may have bought insurance policies while they were resident in India. They may have become NRIs and some may have even changed their citizenship. The first question that arises for this category of NRIs is whether their existing policies in India are affected due to their citizenship change. Such policy holders would not be affected and a claim could still be made on their policies, except health policies in which case, claim is allowed only if treatment is taken in India.
5. Taxation Refer here:
Another common question in most NRI’s mind is whether they could remit money to their spouse’s accounts in India and invest through her account. While this is technically possible, it also allows the Income Tax department to invoke the clubbing clause and tax the NRI, as the spouse may not have any sources of income on her own.
6. Repatriation Repatriation is the opposite of remittance – it is moving money from India to abroad by an NRI. If an NRI wants to sell some assets or inherits sale proceeds of ancestral property, they are required to pay all taxes due, obtain a certificate from a chartered accountant and submit it to their bank for transfer of funds to their overseas accounts.

Make the most use of NRI-advantage!

As NRIs have a higher income earning potential for a limited 10-20 years time period, they could best utilize the time & money to create a secured financial position for themselves through proper goal based planning. The approach to investing is no different for an NRI compared to a resident Indian, but a higher net disposable income would certainly help them attain their goals quickly, if planned well.

Know your Mutual Fund Categories..

In 2017-18, SEBI mandated all Mutual Fund companies to re-categorize their funds into well-defined scheme holdings as defined by the regulator. As a result, fund houses had to align funds with respect to their holdings, change fund names, returns, benchmarks or even mergers with other funds. These changes are as a result of SEBI’s constant endeavor to make the fund selection process investor-friendly.

Today India has about 20+ fund houses and 3000+ schemes, often carrying names that do not reflect the underlying fund characteristic. This presents great challenge to a retail investor to navigate the ocean of schemes & identify the right funds for him/her. To simplify this process, SEBI in Oct 2017, mandated that all fund houses must categorize their schemes under 5 broad schemes
1. Equity
2. Debt
3. Hybrid (Equity+Debt)
4. Solution-oriented (Retirement, Children’s fund)
5. Others (Fund of Funds, Sector/Thematic & Index Funds)
The most useful change by SEBI is allowing only ONE fund under each category by a fund house. This means a fund house having 6 different multi-cap funds would have to merge all 6 under 1 fund and have to name it right to reflect this category.

However, under each of the 5 broad categories of funds, sub-categorization has been permitted as below:
1. Equity – 11 (Large-cap, Mid-Cap, Small-cap, Value Fund etc)
2. Debt – 16 (Short Duration, Credit Risk Fund, Dynamic Bond etc)
3. Hybrid (Equity+Debt) – 7 (Balanced, Balanced Advantage, Arbitrage, Equity Savings etc)
4. Solution-oriented – 2 (Retirement, Children’s fund)
5. Others – 10 (Fund of Funds, Index Funds etc)
The re-categorization drill largely benefits retail investors as they could effectively perform a portfolio review with their investment advisors and consolidate / re-align their portfolios to their long term goals.

Ready to double / treble your returns?

YES, you heard it right – in this article we are going to use a simple comparative analysis to understand how your returns could be doubled by using debt funds and trebled by using equity funds over a 5 year investment horizon.

Fixed Deposit (vs) Debt Funds
Let us say our investment horizon is 5 years. Rs.30 Lacs in FD at 6% interest p.a would fetch a post-tax return of 4.13% (considering the highest tax bracket of 31.2%). Crunching the numbers, your FD would earn Rs.9 Lacs interest in total, on which you would pay Rs.2.8 Lacs in taxes and be left with an accumulated sum of Rs.36.19 Lacs at the end of 5 years.

If you had invested the same Rs.30 Lacs in a debt fund with similar returns at 7% p.a, you could have doubled your returns in 5 years!

Fixed Deposit (vs) Equity Funds
If you had invested the same Rs.30 Lacs in an equity fund with returns of say 10% p.a and had remained invested for the same period, you would pay ZERO tax and be left with Rs.48.3 Lacs at the end of 5 years. That amounts to trebling your returns!!

Fund selection
The above *illustrative* scenarios are presented for one to comprehend how the higher returns, tax advantages and the powerful compounding principle works simple wonders to multiple your returns!! However, do not use it blindly – as to what funds to invest in, when to invest, how long to stay invested, whether to go for lump-sum or SIP and all other questions that you may have, it is best to perform a detailed investment planning with your financial planner!

Although mutual funds comes with its own risks, there is a suitable fund to cater to everyone’s risk appetite and propensity. Perform a careful fund selection with your financial planner, get your tax savings worked out and make a sound investment decision – you are in to reap good returns in the long run!

How are Mutual Funds taxed?

Similar to a residential property, mutual funds fall under the capital asset class and hence the tax laws of capital assets are applicable to units of mutual funds held by an individual. A mutual fund may generate income during its holding period in the form of dividends or bonus units. It could also provide capital appreciation in the long run resulting in capital gains when redeemed or sold. And as with other capital assets, it could be gifted or bequeathed to legal heirs as per one’s will or per intestate laws, whichever is applicable.

Tax classification
As a large variety of funds exist, we need to understand the subclasses under which a particular fund falls so we could determine whether it would qualify for lower taxation or any eligible tax exemptions provisioned. Broadly funds are offered to investors with a dividend or growth option.

Any periodic income received under dividend option of a mutual fund is taxable while dividends directly received by holding of stocks are tax-exempt. However such taxes on these dividends are deducted upfront by Mutual Fund houses (as DDT – Dividend Distribution Tax) and hence not directly taxed in the hands of the investor. The growth option does not provide any periodic income and hence could result only in capital appreciation.