Article Reposted From Economic Times
Bonus season is here. That blessed time of the year when your salary account gets a little bit more than usual, and you get a chance to revel in the surplus. But while the temptation to go on that long-awaited vacation or bring home that iPhone can be extremely strong, remember that one bout of frivolous spending is all it takes to make the money disappear from your account as quickly as it appeared.
This is not to say that you shouldn’t treat yourself to a trip or a shopping spree. There’s no sense in earning a bonus if you don’t enjoy using it. But moderation is key, and it’s important to distinguish between what you need and the things you desire.
There are many ways to put your bonus, or at least part of it to work, depending on your time horizon, risk appetite and tax bracket. Carefully evaluate your financial situation to figure out which aspect needs a little help. For instance, if you have a huge tax outgo, consider investing in the NPS to reduce your tax liability. If you haven’t started saving for your child’s education, your bonus can give you a head start. If your family doesn’t have adequate health insurance, use your bonus to b to buy a family floater.
But it’s not easy to juggle multiple financial goals and figure out where to put your extra cash. Read on to find out the best ways to make the most of your bonus.
1. PREPAY COSTLY AND LONG-TERM LOANS
Home loan rates are on the rise. Use the cash to reduce your debts.
Doing away with debt should be your priority when you have a little extra cash in hand. One can argue in favour of investments that give high returns instead of paying off a lowcost home loan. But being debt free gives the individual freedom from stress and could also improve his credit score.
Priotise your loans based on the interest you are paying. Credit card debt should top your list, followed by personal loans, which can charge anywhere between 10-22% interest. However, do check if the lender slaps charges for prepayment of the loan.
Consider paying off smaller loans, like your car loan, in their entirety, so that you can tick them off the list. The last to go should be loans that give tax benefits, like a home loan or education loan.
There are some obvious benefits of foreclosing a long-term loan. The longer the tenure, the higher is the interest outgo. Just like long-term investments build wealth for you, long term debt burdens you with high interest. “If a penny saved is a penny earned, prepaying a home loan may be the best investment option available right now. Where else can you get 8.5% assured ‘returns’ on the surplus cash?” says Raj Khosla, Founder and Managing Director, Mymoneymantra.com.
When prepaying a home loan, don’t go for the easier option of reducing the EMI. Go for the default option which reduces the tenure of the loan.
2. BUY A SINGLE PREMIUM TERM PLAN
A one-time payment will take care of your life insurance till you are 60.
Are you among the millions of Indians who buy life insurance and then let it lapse by missing the premium deadline? A single-premium term plan may be just the right policy for you. These plans charge a large premium up front, but suit those who either lack financial discipline or may not be in a position to pay the annual premium later on.
However, single-premium policies have higher charges. A 30-year-old man will pay Rs 1.57 lakh for a cover of Rs 1 crore for 30 years. If he went for the regular premium option, he would have paid barely rs 9,000 a year for the same cover. A simple calculation shows that if the buyer puts Rs 1.57 lakh into a bank deposit earning 7%, he will receive Rs 11,000 in interest every year, which will be enough to take care of the premium payment. So, the single-premium option is not very cost effective.
But in a regular premium policy, missing a premium leads to the policy lapsing. You might have to shell out a higher premium when you buy afresh. On the other hand, a single premium plan does not require renewal. A one-time payment will take care of all your life insurance needs till you are 60-65 years old.
3. BUY HEALTH COVER FOR FAMILY
Secure your family’s well being if you don’t already have health cover.
While a growing number of families are acutely aware of the need to have medical insurance, the rest of us often let it slide. Your group insurance policy may not provide sufficient coverage for your family. This is where your bonus comes in. Use it to buy a family floater health plan, which will take care of the hospitalisation expenses of all family members.
Family health insurance packages are more suitable for young nuclear families. A new member can be added quite easily by paying the extra premium, instead of going through the process of getting a new standalone policy for the individual.
An individual health plan for 30-year old costs around Rs 11,750 a year, whereas a floater plan that covers both husband and wife costs only Rs 17,624 a year. Similarly, a floater plan for a family of four (two adults under 40 and two kids) would cost Rs 25,204 a year.
But keep in mind that the coverage of a floater plan is shared between the members. If one member makes a claim during a year, the cover is reduced by that sum and the rest of the members only have the remaining amount to fall back on.
Cost of health insurance cover of Rs 10 lakh
Here’s how much you have to shell out as premium each year for a health cover.
4. SET UP AN EMERGENCY FUND
It can help you tide over tough times.
Preparing yourself for unforeseen circumstances is the cornerstone of financial planning. A contingency fund ensures that you have enough to cover basic living expenses in case of a sudden lay-off or extended illness that prevents you from full-time employment. You can use your bonus to start your fund, or add to it if you already have one.
The thumb rule is to have enough stashed away to cover 3-6 months of expenses, including loan EMIs and insurance premiums. However, this varies depending on factors like the number of earning members in the household, whether or not you have health insurance, etc.
An emergency fund can also help you manage sudden and unexpected expenses, without dipping into your savings or taking a loan. Credit cards can also serve the same purpose, but their overuse can lead to other complications. Unless credit card outstandings are cleared by the due date, a contingency fund might be a better option. Park your money in an instrument that allows easy access and liquidity.
While bank accounts and fixed deposits can work, a liquid fund or short-term debt fund is ideal for this purpose since they provide both liquidity and higher returns. A liquid fund can be opened in any mutual fund house.
5.START SIPS IN EQUITY SCHEME THROUGH A LIQUID FUND
Buy a liquid fund, then shift to equity.
Before the market correction, equity funds were on a roll. Even now, their long-term returns are quite impressive. If you are willing to take some risks and have enough patience, equity funds can give you good returns. But don’t rush to invest in this overheated market. Stash the amount in a liquid fund, and then start a systematic transfer plan into an equity fund. This strategy has twin benefits. One, your SIP investments in the equity fund will cushion you against market volatility. Stagger your investment over a longer period and gain the rupee cost averaging advantage.
Two, the amount will be out of your savings bank account so you will not end up blowing it away. As explained earlier, a liquid fund will also give your slightly better returns than if you were to simply leave the money in your bank account.
6.INVEST FOR YOUR CHILD’S EDUCATION
It’s never too early to start saving for higher education.
Education is a major expense incurred by a parent, and it is rising at over 10% a year. Last week, IIM Ahemdabad hiked the fee of its two year management course to Rs 21 lakh. IIM fees has risen 500% since 2007. Imagine how much it will be when your child is ready to go to college. If your child is in school, you should already have a college fund set aside for her. Starting early means a smaller outflow, since you have a longer investment horizon. But if haven’t started yet, allocating your bonus lump sum to this fund is a good idea. Invest equally in both debt and equity or go for balanced funds to get the ideal asset mix.
If you have a daughter under 10, you can invest in the government’s Sukanya Samriddhi Yojana, which is one of the best debt options available. Even as small savings rates have been cut, the scheme has retained a relatively high interest rate of 8.1%.
You can invest a maximum of Rs 1.5 lakh per year, and the principal invested, the interest accumulated and the payout are all tax-free. But the scheme lacks liquidity. You have to stay invested till your daughter turns 21. After she turns 18 you can withdraw 50% of the corpus.
You will also have to keep investing every year to make the most of the scheme. If you start putting away Rs 45,000 each year for your six year old daughter, at maturity, the scheme will pay out over Rs 20 lakh, which can fund her higher education.
7. INVEST IN FDS FOR PARENTS
Senior citizens have a big advantage when it comes to taxability of interest income.
Experts often advise against investing in fixed deposits because the returns are unimpressive and the interest is fully taxable. However, even it is not a viable option for you, FDs might provide a stable and convenient investment avenue for your parents.
This year’s Budget has given an exemption to Rs 50,000 interest income in a year for those over 60 years. All deposits held by senior citizens across banks, co-operative banks, as well as post offices will be eligible for this exemption.
These glad tidings coincide with another piece of good news for senior citizens. Banks have hiked interest rates of fixed deposits in recent weeks. Some banks are offering up to 8% returns (see table).
What does this have to do with your bonus? Well, you can gift money to your parents and then get them to invest in these highyield fixed deposits. What’s more, if they don’t already have a very high interest income, the amount earned will not be taxed due to the additional tax exemption from this financial year.
Financial gifts to parents do not have any tax implications. The income from such investment are also not subject to clubbing provisions. Though this is a perfectly kosher strategy, don’t give the taxman an opportunity to object. Give a cheque or transfer the money to your parent’s account first. The money should be invested in a fixed deposit through their bank account. Also, make sure you are the nominee of such investments to avoid disputes with siblings.
8. PUT MONEY IN THE NPS
The government-managed scheme can help save tax and augment your retirement savings.
Invest a part of your bonus in the National Pension System (NPS) to save tax. Under the new Section 80CCD (1b), up to Rs 50,000 invested in the scheme is eligible for deduction. This is over and above the Rs 1.5 lakh investment limit under Section 80C.
One of the drawbacks of the NPS, however, is that it offers very little liquidity. You can withdraw from the NPS only when you retire at 60. Premature withdrawals are allowed only in very exceptional circumstances. Only 20% of the corpus can be accessed, and the rest of it has to be used to buy an annuity. Even at maturity, it is mandatory to buy an annuity with 40% of the corpus.
While this seems unfair, you can’t ignore the substantial tax savings the scheme offers. Further, the long lock in ensures disciplined investing over the long term, although the pension payouts are taxable. It makes sense to invest in NPS if you have a very high tax outgo and want to cut it down.
9. MAKE YOUR HOME ENERGY EFFICIENT
A few upgrades will pay off in the long term.
It might not seem like a priority now, but investing in certain energy efficiency measures for your home can save you a fortune in electricity bills over the long term. India has abundant solar energy, and you can harness enough for you needs by installing a few solar panels on your rooftop or balcony. Start by studying your electricity bill and figuring out how many units your household consumes in a day. For instance, the average home with two or three bedrooms will need 15,000-18,000 watts per day. You can install the necessary number of panels, or use solar energy to power certain appliances like water heaters and lighting, while relying on the electricity grid for the rest.
In certain areas, like Delhi, you can get on the grid and avail of net metering with yearly settlement. Every month, the units generated from your solar panels will be subtracted from the units your household consumed, and you only have to pay the bill for the net units consumed. If the rooftop plant produces more power than you consume, you will not be billed and the excess power will be carried forward to the next month.
Other measures like buying energy efficient appliances (rated at least three on the Energy Star rating), replacing all incandescent light bulbs with CFLs and LEDs which use 25-80% less electricity, painting the roof and outer walls with reflective paint and using double and triple glazed window panes for insulation, can also help you save electricity. An energy-efficient home is a gift that keeps on giving, so consider using a part of your bonus amount to buy the necessary equipment.