Explanation of Tax Benefits

Premiums paid for Life insurance - Deduction under Section 80C

1. Category of assesses allowed deduction: Individual assessee and Hindu Undivided Family assessee.
2. Eligible Savings: Premiums paid or deposited by assessee to effect or to keep in force insurance on the life of following persons:
   • In case of individual assessee – Himself/Herself, spouse, children of such individual
   • In case of HUF assessee – any member
3. 20% limit: If the amount of premium paid in a financial year for a policy is in excess of 20% of the actual capital sum assured, then deduction will be allowed only for premiums upto 20% of the sum assured.
4. Limit on amount of deduction: Deduction will be restricted to investments upto Rs 100,000 in savings specified under Section 80C (including life insurance premiums). If any investments have been made under Section 80CCC and 80CCD, then the qualifying amount under Section 80C will stand reduced to that extent.

Premiums paid for Pension plans - Section 80CCC

1. Permitted Deduction: Section 80CCC allows for deduction of premiums paid under a pension plan. As per this Section, premiums paid upto Rs 10,000 (till FY 2005-06) & Rs. 1 Lakh (from FY 2006-07) by an individual is allowed as deduction from his total income.
2. Disallowance: This benefit will be reversed if the policy lapses / is cancelled.
3. Limit: It may be noted that from FY2005-06, the limit of deduction under Section 80CCC will be part of the overall limit prescribed under Section 80CCE.
4. Receipt under Policy: Amounts received on surrender (whole/part) of annuity plan, amounts received as Pension is taxed as income.

Premiums paid for medical insurance - Section 80D

1. Category of assesses allowed deduction: Individual assessee and Hindu Undivided Family assessee.
2. Eligible premiums: Premiums paid by assessee by any mode other than cash out of his taxable income to effect or to keep in force an insurance on the health of following persons:
   • In case of individual assessee – Himself/Herself, spouse, dependant children and parents. The condition of dependency of parent has been removed from FY 2008-09. In other words, even if the parent is independent, the individual can pay the premia and claim the deduction.
   • In case of HUF assessee – any member of HUF
3. Deduction and upper limit: The qualifying amounts under Section 80D for self, spouse and dependent children is upto Rs. 15,000/- and additional deduction upto Rs. 15,000/- for the parents (from FY 2008-09 onwards). However, a higher amount of upto Rs 20,000/- is permitted if the person, for whose health insurance the premium was paid, was aged 65 years or more at any time during the financial year in which the premium was paid. Such amounts of premium paid would be allowed as deduction from the total income of the assessee.

Overall deduction limit - Section 80CCE

A new Section 80CCE has been inserted from FY2005-06. As per this section, the maximum amount of deduction that an assessee can claim under Sections 80C, 80CCC and 80CCD will be limited to Rs 100,000.

Benefits under insurance policy - Section 10(10D)

As per Section 10(10D) of Income tax Act, 1961, any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy is exempt from tax.
However, this rule does not apply to following amounts:

• sum received under Section 80DD(3), or
• any sum received under a Keyman Insurance Policy, or
• any sum received other than as death benefit under an insurance policy which has been issued on or after April 1 2003 and if the premium paid in any of the years during the term of the policy is more than 20% of the sum assured.

Tax Rates for Individuals

The rates of income-tax for FY 2008-09

Total Income (Rs.)	Rate of Tax
	Senior Citizen	Women below 65 years	Others
Upto Rs 150,000/-	Nil	Nil	Nil
Above Rs 150,000/- to 180,000/-	Nil	Nil	10%
Above Rs 180,000/- to 225,000/-	Nil	10%	10%
Above Rs 225,000 to Rs 300,000	10%	10%	10%
Above Rs 300,000 to Rs 500,000	20%	20%	20%
Above Rs 500,000/-	30%	30%	30%

Surcharge on Income Tax:

In case where the Total Income exceeds Rs 10,00,000, there would be a surcharge @ 10%.Marginal relief is available to assessee whose income just exceeds Rs. 10,00,000.

Education Cess on Income Tax

Edcuation Cess @2% will be payable on the amount of income tax (including surcharge).

Secondary & Higher Education Cess on Income Tax

Additional Education Cess @1% will be payable on the amount of Income tax (Including surcharge).

‘Income’ amidst falling interest rates

Income funds can gain a substantial size of one’s portfolio for longer term in the current falling interest rate scenario but investment depends on the investor's risk appetite, investment horizon and other investment options.

At a time when most of the investment products have given negative returns, investors are left with fewer options to park their hard-earned money into. However, falling interest rates can be taken advantage of by investing in income funds, as these funds tend to perform well when the interest rates are falling.

What are Income funds?

Income funds are debt funds that generally invest in fixed income securities, such as bonds, corporate debentures, government securities and short-term instruments, such as commercial papers.

Along with stability of capital, such schemes emphasize on providing regular income, which comes from coupon payments. The instruments in which the fund invests generate fixed returns and as such the fund can provide income to investors.

Typically, these funds bet on interest rate fluctuations, their performance being in inverse proportion to the interest rates. Thus, when there is a drop in interest rates, the yield from such schemes increases and vice-versa. At present, with inflationary pressures cooling off, the interest rates are expected to move southwards. This can be a good opportunity for investors to earn returns by allocating a portion of their portfolio towards income funds.

Depending upon the interest rate movement anticipated, the fund manager can invest in bonds with different maturities which could range from anything between a year to fifteen years.

Advantages

Higher returns through flexible maturity

Owing to their flexible maturity profile, income funds gain an upper hand over conventional debt products, like bonds and fixed deposits. Whenever there are lesser chances of a rise in interest rates, fund managers prefer to extend the duration of the fund’s portfolio, which increases the return of the portfolio. As against this, fixed deposits do not have any such flexibility.

Tax gain

Income funds offer an additional benefit of tax advantage, making them a good alternative to fixed deposits. This is because interest earned on fixed deposits is not exempted from tax..

Charges for premature withdrawal

Most of the banks charge a fee for premature withdrawal of fixed deposits, which is not true in the case of income funds.

Tax Implications

Debt funds, except liquid and money market funds, pay a Dividend Distribution Tax of 14.16 per cent (When income is distributed to Individuals and HUFs). In the long term, they have the benefit of Indexation, which gives the option of paying taxes – 20 per cent with indexation benefits and 10 per cent without indexation benefits (whichever is lower).

Risk factor

As compared to equity funds, these funds are less risky. However, these funds are subject to fluctuations in interest rates. Such risks are high over the short term; hence, investment in income funds should ideally be for a slightly longer duration – at least a year.

Another risk faced by income funds is the default or credit risk. It refers to the possibility that the issuer of the fixed income security may default, that is, the issuer may be unable to make timely payments of the principal and interest amounts due to some financial crisis arising at the time of payment. While there is no default risk on government securities, the same does not hold true for corporate debt, where there exists a possibility of default. Fund managers, thus, strive to allocate most of their corpus to high-rated debt, whose issuers have strong creditworthiness.

Conclusion

Over the long term, income funds tend to generate better returns than short-term funds. Investments in income funds should be done at the peak of the interest rate cycle. Systematic investment plans are a good way of capturing growth instead of committing an upfront principal. This can be a good alternative to fixed deposit as the product offers an additional benefit of tax advantage too.

Such schemes can be a part of the portfolio of retired individuals as well as young investors.

Understanding cyclical stocks and their high risk – high return strategy

The world of finance conjures many images, one being that of a Ferris wheel. Economic cycles too seem similar to a Ferris wheel – constantly rotating as your investments sometimes fly high during the good times, and crash to abysmally low levels during downturns.

What are these economic cycles in the first place? Let us look at this in more detail.

Synopsis:

• Cyclical stocks are great investment opportunities
• They call for a high risk – high return strategy
• They follow economic cycles, and can be selected basis some indicators
• Price to book ratio, insider buying, cash reserves, and industrial cycles should be considered

Understanding economic cycles

A Ferris wheel completes a revolution within minutes. By contrast, the economic cycle takes years to spin, with distinct phases that can be observed before it completes a full revolution.

These phases can be broadly categorised as:

i) Growth or Expansion: In this phase, the economy experiences a growth in production, a low interest rate regime and a growth in prices.

ii) Peak: After the expansion stage, the economy hits a peak of growth, with production surpassing real demand.

iii) Recession or Contraction: The peak leads to a crisis due to the inability of the economy to grow further. Therefore, there is a slowdown in production, and a high interest rate regime is evident.

iv) Trough: This is the lowest point of the recession in an economic cycle, and the period has the lowest economic activity.

v) Recovery: With prices having fallen to their lowest ever, markets recover because of attractive valuations. In the broader economy, the recovery happens due to low prices as well.

What are cyclical stocks?

When the economic cycle is in an upswing, certain industries and sectors perform well, such as shipping, leisure, infrastructure and automobiles. During this phase, the demand for goods and services such as cement and power is on the rise.However, when the economy starts to decline, countries tend to reduce spending on such industries. The stocks of companies that produce such products and services, which are impacted by business cycles, are known as cyclical stocks.

Investment in cyclical stocks

Does it make sense to invest in cyclical stocks?

At first glance, they might seem to be a risky proposition, but the higher risk also holds the potential to give a higher reward on your investment.

Cyclical stocks can prove be a good medium term investment as they tend to outperform stocks of companies that show consistent performance when the tide of the economic cycle begins to change towards growth. However, timing is crucial, and one of the greatest tools that can be used to pick a great cyclical stock is the Price to Book Ratio, calculated by using the following formula:

Price to Book ratio = Stock Price/Total Assets of the company-Intangible Assets and Liabilities.

When prices are lower than the book value, there are chances that the stock may rise to coincide with book value. These stocks typically perform well during an economic recovery.

Another good indicator of a cyclical stock is insider buying. If a company’s management is busy buying its own stock, it could be an indicator for good times ahead for the stock you are considering.

Companies with good cash reserves are also a good pick. If a company is not capable of surviving a recession, it will certainly not qualify as a good investment decision.

Conclusion: As investment opportunities, cyclical stocks can be an important part of your portfolio. They present great investment opportunities for investors, who have an appetite to handle the higher risk.

The main risk is that when the economy is doing well, these stocks rise quickly, but when a recession sets in, cyclical stocks can tumble just as fast.

Studying the balance sheet of companies is important when you are looking to invest in cyclical stocks. It is also important to know the industry and the industrial cycle of the companies you looking to invest in, since each industry has its own cycle.