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Investing is a constant battle against inflation, investment expenses and taxes," said Jim Dahle, a doctor and financial blogger. For most people, managing money is confusing and difficult. There are some basic challenges households face in saving the right way, which is leading to a decline in the ratio of household savings rate to the gross domestic product (GDP).
Here are three issues and suggestions around them to transform the nature of household savings.
Not knowing how to save for money goals
Retirement, children’s education and healthcare are common financial goals for the educated in India. While the National Pension System (NPS) is a great way to save for retirement, the restriction of investing 40% of the retirement corpus into an annuity can be removed and individuals should be allowed to withdraw this amount tax-free. This will lead to greater adoption of NPS for retirement planning.
There needs to be a scheme to save for children’s education, just like there’s one for retirement. Most individuals find it difficult to save and keep track of specific goals, as they tend to spread investments across various instruments. A better and easier way could be to have a “Children’s Savings Account" structured similar to NPS in terms of the investment being tax deductible (up to a limit) and featuring different scheme options and different fund managers. The account would be used to save for children’s higher education and funds can be withdrawn only for education purposes on producing requisite documentation.
Further, investments into retirement planning and children’s education schemes from mutual funds should qualify for 80C deduction. This way, an individual would have two-three schemes to save for each of these goals, which provide tax benefits as well as the convenience to invest only for a specific goal. This would make it easier to plan and keep track of financial goals.
Paying for healthcare-related expenses is another big challenge faced by the common man, especially senior citizens. Towards this, a health insurance scheme for senior citizens, paid for by the individual but providing group cover benefits, can be instituted by the government. This will help senior citizens access insurance at a lower cost, with more benefits and lesser waiting periods and exclusions.
Nudges required to save
Decisions around investments (entry and exit) are primarily driven by the tax structure of the investment as well as the volatility in the scheme. Hence, investors tend to invest in equities for short periods and end up with volatile returns. To build the culture of long-term investing (and thus compounding wealth), the current capital gains structure should be changed. Currently, equity investments made for more than a year qualify for long-term capital gains tax. This period should be increased to at least three or five years. Similarly, debt investments are meant for shorter duration and, hence, the long-term capital gains holding period for debt mutual funds can be reduced to a year.
Nudges in personal finance have gone a long way in inculcating better saving habits. Currently, in NPS, non-corporate account-holders tend to invest only up to the tax deduction limit of ₹50,000 per year. This amount may not suffice to build a retirement corpus. An automatic escalation clause can be introduced in NPS so that people can invest more as their income grows. This will be especially useful to those who are self-employed and other non-corporate account-holders.
Individuals fall prey to mis-selling
Individuals are known to gravitate towards products promising high returns, without assessing the risks involved. Even if risk disclaimers exist, they do not understand the same. Having common risk disclaimers for all market-linked instruments like mutual funds, unit-linked insurance plans (Ulips), endowment policies, which clearly list out the risk involved, is required. For products like company fixed deposits or non-convertible debentures (NCDs), too, disclaimers are essential to make people aware of the risks involved in these products. Similarly, gold schemes from jewellers or chit funds need to mention if they are regulated.
Given the spate of defaults by company deposits, chit funds and gold schemes, regulators need to step up awareness through the media. They need to highlight which products can give guaranteed returns and which are regulated by a government entity. Most lay investors believe that other than mutual funds, all other products give guaranteed returns, which is not the case.
Further, the transparency standards and commission structures need to be the same across products. Currently, insurance funds, pension funds and mutual funds do not have the same disclosures. This leads to investors punishing more transparent schemes and investing in opaque products. Also, the commission structure across products varies, leading to products like Ulips and endowment plans being recommended over lower fees products like mutual funds, Public Provident Fund (PPF) and NPS which may work better for investors.
Having more goal-oriented products with nudges and appropriate tax structuring along with a level-playing field for all products will go a long way in building household savings which will ultimately have a positive impact on the GDP.
I do hope to see some of these suggestions implemented by finance minister Nirmala Sitharaman in the imminent Budget to make financial decisions simpler for the majority of investors.
Mrin Agarwal is a financial educator, founder director of Finsafe India Pvt. Ltd and co-founder of Womantra