Let us look at what assets you are likely to draw upon while in retirement, and how it is taxed. By the time you retire you would have accumulated some direct equities, mutual funds – debt, equity and balanced, own provident fund, gratuity, public provident fund, Nps, bank fixed deposits, bonds, real estate, retirement plans from a mutual fund, retirement plans from a life insurance company, and the likes.
Let us see from a tax point of view what you should / should not do when you are YOUNG so that suddenly at the age of 60years you are not left with tax inefficient assets.
1. Direct equities: In India this is the darling from a tax point of view. Dividends and capital gains both are tax free. If you have accumulated a decent direct equities portfolio and are confident of managing it during your retirement, keep this going till your age of 70-75 years, Use that money to buy an annuity at that age – use up say AT LEAST 50% of the equity portfolio to buy an annuity without return of premium.
2. Equity mutual funds as well as balanced funds (with more than 65% in equities) are in the same category as direct equities – and when you are accumulating for the long term please opt for the Growth option.
3. Debt funds: If you have accumulated money in debt funds over a long period of time (Growth plan) you are likely to have accumulated a decent sum of money in these accounts too. In case you withdraw from here on a regular basis (SWP: Systematic withdrawal plan) you are likely to pay a very low rate of tax. This is treated as capital gains and the money accumulated for say 20 years will come back to you almost tax free. This is because of the taxation structure and capital gains being taxed less than regular income. This is one solid reason why you should choose a debt fund over bank / company fixed deposits.
4. Your own provident fund comes back to you as a lumpsum which you can invest as you wish. This amount is tax free and you get this within a month or two post retirement.
5. Gratuity: Most of the gratuity plans in India are bought with LIC – this gets commuted and becomes a pension. The amount is generally received on a regular basis – monthly or quarterly. This is FULLY TAXABLE in your hand. The annuity is just like your salary that you were receiving when you were in service. No deduction or indexation or anything is available for this.
6. NPS, Pension from employer, etc. Pension from a life insurance company: are all treated the same as the annuity from the gratuity. These are the most inefficient ways to invest, but are very popular because the media pushes these things very hard. Also life insurance companies which have sold pension plans fall under this category.
7. When you accumulate a pension under a pension policy of a mutual fund, you are better off because you have an option of when to withdraw, how much to withdraw, etc. – the taxation is also friendlier. You are treated like a debt fund and the taxation is like capital gains. So you will be taxed much lesser than the taxation if the plan were in a life insurance company.
Post office schemes, bank fixed deposits, etc. are taxed on an actual basis – when you get the income / when it accrues you pay the tax.
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