The impact of “taxed at slab”

It’s often scary to hear the phrase “taxed at slab” because it means a relatively larger chunk of our profit is taken away by the government.

Many mutual fund categories are now taxed at slab. This has caused enough concern among investors to spur AMCs into creating weird mutual fund schemes. I know of at least Edelweiss Multi Asset and Parag Parikh Dynamic Asset Allocation funds. I am sure more such funds are coming from various AMCs.

But what is the impact of “at slab” taxation on long-term investments? We look at a few tax scenarios of a ₹50,000 per month SIP.

Estimated corpus @ 10% annualised return over 10 years

It should be no surprise, but a 30% tax bill is twice as large as a 15% tax bill and thrice as large as a 10% tax bill.

Screenshot from Groww SIP Calculator (click image to enlarge)

• Pre-tax corpus: ₹1,03,27,601
• Post-tax corpus with 30% tax and 4% cess: ₹89,77,389
• Tax owed is ₹13,50,212.
• 13.07% of the final corpus is owed as tax.
• Post-tax corpus with 20% tax and 4% cess: ₹94,27,460
• Tax owed is ₹9,00,141.
• 8.72% of the final corpus is owed as tax.
• Post-tax corpus with 15% tax and 4% cess: ₹96,52,495
• Tax owed is ₹6,75,106.
• 6.54% of the final corpus is owed as tax.
• (Why 15% tax? Assuming indexation brings down the acquisition cost, the effective tax rate may be 15%. Just an unscientific estimate.)
• Post-tax corpus with 10% tax and 4% cess: ₹98,77,530
• Tax owed is ₹4,50,071.
• 4.36% of the final corpus is owed as tax.

Estimated corpus @ 12% annualised return over 10 years

For the same investment duration, higher return rate results in higher tax owed (as a percentage of the corpus size).

Screenshot from Groww SIP Calculator (click image to enlarge)

• Pre-tax corpus: ₹1,16,16,954
• Post-tax corpus with 30% tax and 4% cess: ₹98,64,464
• Tax owed is ₹17,52,490.
• 15.09% of the final corpus is owed as tax.
• Post-tax corpus with 20% tax and 4% cess: ₹1,04,48,628
• Tax owed is ₹11,68,326.
• 10.06% of the final corpus is owed as tax.
• Post-tax corpus with 15% tax and 4% cess: ₹1,07,40,709.
• Tax owed is ₹8,76,245.
• 7.54% of the final corpus is owed as tax.
• (Why 15% tax? Assuming indexation brings down the acquisition cost, the effective tax rate may be 15%. Just an unscientific estimate.)
• Post-tax corpus with 10% tax and 4% cess: ₹1,10,32,791
• Tax owed is ₹5,84,163.
• 5.03% of the final corpus is owed as tax.

Estimated corpus @ 12% annualised return over 5 years

For the same 12% return, shorter investment duration results in lower tax owed (when looked at as a percentage of the corpus size).

Screenshot from Groww SIP Calculator (click image to enlarge)

• Pre-tax corpus: ₹41,24,318
• Post-tax corpus with 30% tax and 4% cess: ₹37,73,530.
• Tax owed is ₹3,50,787.
• 8.51% of the final corpus is owed as tax.
• Post-tax corpus with 20% tax and 4% cess: ₹38,90,460.
• Tax owed is ₹2,33,858.
• 5.67% of the final corpus is owed as tax.
• Post-tax corpus with 15% tax and 4% cess: ₹39,48,924.
• Tax owed is ₹1,75,394.
• 4.25% of the final corpus is owed as tax.
• (Why 15% tax? Assuming indexation brings down the acquisition cost, the effective tax rate may be 15%. Just an unscientific estimate.)
• Post-tax corpus with 10% tax and 4% cess: ₹40,07,389.
• Tax owed is ₹1,16,929.
• 2.84% of the final corpus is owed as tax.

Conclusions

To recap, these are the objective takeaways from the numbers.

• Tax at 30% is significantly higher than 10% or 20%. (Of course!)
• The higher the rate of return, the higher the taxes owed.
• The higher the investment duration, the higher the taxes owed.

The more nuanced and subjective aspects are interesting to think about. For a 10 year debt SIP, if the tax difference is 8% of the corpus vs 13% of the corpus, the choice is easy for me: I’d pay the tax to keep my debt portfolio clean and simple. This is partly because I take barely any credit risk in my debt portfolio. High tax for a low-risk investment is fine.

Other asset classes are not so straightforward. Am I okay to invest in international equity and not be compensated for the risk (with a lower tax bill)? I don’t currently know what my stance is.

Hopefully, we can all think about these nuances and make the tradeoffs that we are comfortable living with.

Random thoughts after our Bali visit

Some scattered thoughts from our recent visit to Bali, Indonesia:

Pura Tirta Empul in Bali

• While I don’t hate my job, it probably is very stressful. I am not consciously aware of the stress, but my constant ailments pretty much disappeared during the trip, even when I had stopped taking the regular medicines.
• One of the best things that happened during this trip was bonding with my (8 years old) son. I never thought I’d be able to connect with him at a different level, but this trip made that possible. This is itself reason enough to keep travelling with my children.
• A day is 8 to 10 hours long. Be it work or leisure, it should be just that length. Adults in the party (my wife and I) were okay to stretch the days to 12 hours, but the children needed their “me” time. They had to put their feet up and watch their YouTube videos or run around playing in the hotel room before they’d go to bed. I need to remember this next time and limit the number of activities we pack into each day.
• I have always found flight travel awful. Dragging 3 sleep deprived and dehydrated children through airport gates and immigration reaffirmed my dislike for flying.

The sorry state of Indian banks

What do you expect a business to do? To add value to its customers’ lives and charge a fee for the value addition. A win-win arrangement where both the business and the customers voluntarily work together for their own benefit.

What do Indian bank employees do? They simply ask the customer for “favours” to benefit the business at the cost of the customer. (Just to be clear, I am talking in general about banks in India; not the entity named Indian Bank.)

This isn’t new; this has been happening for well over a decade now from what I have seen. Whenever I interact with bank employees, most of them push an insurance product. They don’t even pretend that they are helping me, the customer. They openly describe these as requests for favour.

My family members and I have received calls in the past few weeks from bank employees with requests to open fixed deposits so their branch’s balance sheet shows inflated numbers when the financial year ends. I opened a 10 days fixed deposit because I felt I could help a bank employee. That person knows that a 10 days fixed deposit doesn’t serve a meaningful benefit to anyone—neither to the bank nor to me. But still they were happy with my opening that deposit.

Our banks have been measuring the wrong things and incentivising the wrong things for a very long period. Until banks get serious about adding value to customers, our banks will stay as rotten as they are now.

Image credit: rawpixel.com

Until a meaningful positive change happens, I’d continue to repeat my advice: “Do not ever tell your bank that you have money to invest. They are uninterested in your desires and dreams. They only think about how they can transfer some of your money into their own coffers.”

Can we use ULIPs as tax-free debt assets?

It was a shock to pretty much everyone when the government changed tax rules for debt mutual funds in the 2023 budget.

AMCs have since then been trying to adapt by shoehorning “debt-like” funds into unrelated categories. For example, Edelweiss has a multi-asset fund that is offered as a debt fund replacement (but with better taxation). Parag Parikh has launched a similar fund in the dynamic asset allocation category (the “balanced advantage” category).

I was wondering if ULIPs—the infamous Unit Linked Insurance Policies—can be used for debt investment. An investor can invest up to ₹2,50,000 every year into ULIPs and get tax free returns. There is a lock-in period of 5 years, but the funds become redeemable after 5 years irrespective of how long the policy term is. Since the returns are tax free, ULIP debt investments can be attractive even if they earn 1 or 2% less return than an average debt mutual fund.

That’s the theory. But we need to check if that theory holds any water.

The story of my ULIP investment

I started a ULIP 2 years ago to help a bank employee meet their sales target. I had been thinking of repurposing this ULIP as a pure debt investment. But I didn’t pull the trigger as I wasn’t 100% sure. Coincidentally, I received the annual statement for this policy last week, and it was eye opening.

2022 statement for my ULIP (click to enlarge)

2023 statement for my ULIP (click to enlarge)

If you can’t see the issue in these statements, you’re not alone. Most people can’t spot this.

There are 2 kinds of deduction in the statements.

• “Mortality Charge” is what the insurer is charging for providing life cover. This is tiny because pure life insurance is very cheap. This charge can be ignored.
• The other deduction, called “Allocation Charge”, is more sinister. This is for charges like policy administration, agent commission, etc. In 2022, when this policy started, they deducted 12% of the premium as the allocation charge. In 2023, this deduction was 8% of the premium.

Let’s look at the impact of allocation charges more carefully. I paid ₹60,000 as the premium in 2022. Of this, ₹7,200 was deducted upfront for fees and commissions, and only the remaining ₹52,800 was invested. To break even by the end of the first year—i.e. for the fund value to be ₹60,000 by the end of the first year—this investment needed to grow by 14%! Making such a return is no easy feat, so it is no surprise that the policy value never touched ₹60,000 throughout the first year.

I paid the next ₹60,000 premium by the end of the first year. Again, ₹4,800 was deducted from this money and only ₹55,200 was invested causing the investment to stay underwater for most of the second year too.

My ULIP’s fund value over the first 22 months

A policy that started in March 2022 has remained underwater till September 2023! This was the reality for a 70:30 portfolio. It took the 2023 equity rally and a big 70% equity exposure to get this investment to break even. Since debt returns are subdued, ULIPs with 100% debt portfolio may even stay underwater for 7+ years.

My hypothesis is still correct: if pure debt ULIPs make 2% less return than average debt mutual funds, ULIPs will be an attractive option. But my assumption that ULIP returns will fall short only by 2% is way off the mark.

Is there a way to salvage ULIPs that are already bought?

What follows is an untested idea. Say, I let my ULIP stay as a equity+debt blend for the first 7 years or so. Hopefully, the portfolio grows to a reasonable size. After this, I can switch the entire portfolio to debt. Given there is no allocation charge after the first 5 years, this can probably be considered a reasonable debt investment. Fresh investments won’t be possible, but partial and full withdrawals will be available.

If you already have a ULIP, this may be a way to salvage the situation. But don’t buy a new ULIP only to get tax-free debt return. ULIPs make a lot of money for insurance companies and agents. Investors have a slim chance of making money through ULIPs.

Back to my roots

I grew up reading magazines at home. Political news commentary, children’s magazines, lifestyle magazines, science magazines, computer magazines, and whatnot.

Somehow the reading stopped once I moved out to live on my own. Now I am trying to go back to my roots.

One of the magazines in the picture is a brand new subscription; I have no idea how enjoyable and insightful it’s going to be. But I can’t know until I give it a try, can I?