How can children help their retired parents to set up their finances?
17 Aug 2022 - Contact Sayan Sircar
13 mins read
This article shows the steps to set up an investment portfolio for retirees with the help of their children.
Table of Contents
- How to set up investments
- Pre-requisites to be completed
- Contribution to family expenses by the children
- RBI issued government bonds (Gilts)
- Fixed deposit in banks
- Saving schemes like SCSS, PMVVY, and Post Office
- Pension plans
- Mutual funds
- High dividend-paying stocks
- Other options
- A point on taxation
How to set up investments
This article will cover cases where resident Indians, as opposed to NRIs whom we cover separately here, can ensure that their parents in India have regular income with the least possible setup and maintenance hassles, simple taxation and low to no activities needed in the physical world by focusing on online transactions.
We will focus on these investments’ simplicity, ease of maintenance and safety. We will avoid situations that involve running around by elders like:
- continuous bank visits to perform KYC and other activities
- filling, submitting and depositing Form 15G/15H offline
- dealing with real estate properties, renters, agreement signing, and related hassles
The point of this article is not to imply that the children have more knowledge than the parents but to ensure both generations work together in the retirement plan.
We will explore the following options:
- Contribution to family expenses by the children
- RBI issued government bonds (Gilts) that pay guaranteed coupons every six months
- Saving schemes like SCSS, PMVVY, and Post Office
- Pension plans
- Debt and equity mutual funds
- Fixed Deposit
- Dividend-paying stocks
We will cover using the following flow:
- a parent retires and receives a large sum of money as retiral benefits
- the child, who is savvy with personal finance, wishes to set up investments for the parents
- once setup, the investments proceed with minimum hassles
Warning: The children should remember that their understanding of various investment options and risk tolerance will differ from their parents. Recommendations of investing in risky products, like equities and mutual funds, might be received with scepticism and mistrust regarding how the products work. In such cases, the children should not force the issue.
There is a word of caution as well. Retirees are a prime target for relationship managers for selling high commission, poor return products like ULIPs and endowment plans. Retirees need health insurance. They do not require life insurance.
Pre-requisites to be completed
Before creating a retirement corpus, ensure that these are in place:
- an emergency fund with 6-12 months of expenses. Both parents and the children should have access to this account via debit card and Netbanking for emergency usage
- a sinking fund for insurance payments (health, car) and recurring known expenses (building maintenance, holiday travel etc.)
- a health insurance policy for 10-15 lakhs as a base policy with a 50-100 lakhs super-top up. This will be expensive but essential in case such a policy is not already in place
- no high-interest debt like credit card or personal loans. An outstanding home loan should be paid off at the point of retirement using the retiral benefits
Contribution to family expenses by the children
Priority: Very high
A simple bank account transfer, automated using an NEFT standing instruction, will work if the parents are savvy with ATMs. Children can also pick up the bill payment (electricity, internet, mobile, DTH etc.) via their bank or bill payment apps.
There is no tax on the parents who receive money from their children.
RBI issued government bonds (Gilts)
Priority: Very high
An RBI-issued long-term government bond is a safe option that pays half-yearly interest (called a coupon) and gives back the principal at the end of the period. You can purchase this bond via RBI’s Retail Direct Scheme or brokers like Zerodha.
These bonds are available with maturities from 91 days to 40 years. Investments may range from ₹10,000 to ₹2 crores per PAN.
The most significant benefit of this scheme is that due to the government of India’s guarantee on coupon payments and return of principal, there is no risk of receiving interest and principal. You must remember that the interest payments are fixed and will not increase over time with inflation.
For example, if you buy a 2062, 7% coupon bond at ₹106 by investing ₹50 lakhs, then you get:
- notional value of the bond purchased = 100 * 50/106 = ₹47.17 lakhs
- interest payment every six months = 0.5 * 7% * ₹47.17 lakhs = ₹1.65 lakhs (this is taxable) and comes without TDS into the bank account
- ₹47.17 lakhs come back in 2062 in the bank account when the bond matures without any TDS or capital gains tax
- this bond gives an income of 2 * 1.65 lakh * (1-30%) [assuming 30% tax rate] = ₹2.3L/year or approximately ₹19,250/month. Splitting the investment in the name of both parents will reduce the tax impact
It will be prudent to hold these bonds in a joint mode with your parents so that transmission, in case of their demise, is hassle-free.
You can use this formula to calculate monthly income from bond price and coupon rate:
Monthly income = 100 * Coupon * Investment / Price / 12 * (1 - TaxRate)
Here, investment = 50 lakhs, price = 106, tax = 30%, coupon = 7% and hence the monthly income = 100 * 0.07 * 50,00,000 / 106 / 12 * (1 - 0.3) = ₹19,250
You can spread out buying the bond over a few months to allow income every few months like this:
The example above shows two bonds purchased three months apart, allowing interest payments every three months.
Steps to follow:
- choose how long you need this income to be there based on the expected lifespan. For example, if you expect your parents to be alive until, say, the mid-2050s, then choose a 2060 maturity bond
- calculate the income based on the current bond price and coupon rate for the 2060 bond based on the formula above
- if more income is needed a few years later due to prices increasing in India, then buy a new bond to generate additional income
- buy bonds in each parent’s name to minimise the loss due to taxes. If the taxable income per head is below ₹5L/year per parent, using the benefit of Section 87A, then this income will jump from ₹19,250 (4.6% yield) to ₹27,500 (6.6% yield)
- RBI direct bond account can be opened and maintained online or use brokers like Zerodha
The concept of RBI bonds is explained in detail here: How to use the RBI Retail Direct Scheme to get guaranteed income?
Fixed deposit in banks
Fixed deposits (FD) are a perennial favourite of retirees and offer higher rates, usually 0.5%. However, fixed deposits have a few pros and cons:
- liquidity and safety are standard features since the FD can be broken anytime if needed or even used as an overdraft
- the major disadvantage of FD can be the fact that the maximum FD duration is only 10 years. After 10 years, the FD will have to be renewed at the expected future lower rates
- FDs are also taxable at slab rates and are less tax efficient than debt mutual funds
For banks, you should go with large banks like SBI, HDFC or ICICI (due to their SIFI status). Opening FD in these three banks will maximise peace of mind since these banks are considered too big to fail. One may argue that all banks are equally safe due to the existence of DICGC insurance up to ₹5 lakhs, but that might take longer than the proposed 90 days since liquidation proceedings may take longer. Ultimately, it is a case of, using a driving analogy, buying a high-safety car vs relying on others not hitting you on the road while driving.
Saving schemes like SCSS, PMVVY, and Post Office
There are a few schemes with minimal risk that you can consider:
- Senior Citizen Savings Scheme (SCSS): Investors over the age of 60 are eligible to invest uptown of ₹ 15 lakhs with a quarterly payout of interest (around 7.4% today) that is taxable. The scheme matures in 5 years, and the investment is eligible for an 80C tax deduction. You must invest within a month of receiving retirement benefits from the employer and is available from the post office as well as banks
- Post Office Monthly Income Scheme (POMIS): This is a 5-year scheme offering 6.7% currently (TDS applicable) that you can open singly (up to ₹4.5 lakhs) or jointly (up to nine lakhs) that offers monthly taxable income
- Post Office deposit: This is a standard FD like that from any other bank. RD facility is also there
- National Savings Certificates (VIIIth issue) (NSC): This offers 6.8% compounded annually with a cumulative payout on maturity in 5 years. There is no limit on the investment amount, and the maturity amount is taxable
- Kisan Vikas Patra (KVP): This scheme offers to double the investor’s money per the applicable interest rate. If the rate is around 7%, money will double around ten years
Always check the India post website for the latest rates and terms before investing. While these options have existed historically, their features are superseded by the RBI bond option in the previous section.
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Pension plans that generate a fixed income for life may be an option for someone looking for an excellent fit-and-forget solution. You can gift the money to your parents and let them take a pension plan in their name. You should compare the annuity rate with the RBI bond return before purchasing.
There are a few problems:
- returns post-tax may be low
- 1.8% GST is levied on the premium paid. This means that you pay 1.8 lakhs extra per crore of premium when you purchase the policy
- the requirement of giving a life certificate every year
Debt mutual funds are an excellent FD replacement from a safety, liquidity and taxation perspective if:
- chosen correctly out of the 15+ debt fund categories
- their tax treatment, when held longer than three years, is better since capital gains are taxed lower than those in the highest tax bracket in retirement
- they are liquid without any premature withdrawal penalty since you can redeem only the amount you need.
You can read more on this topic here: Mutual Fund vs Fixed Deposit - where should you invest?
On the other hand, equity mutual funds offer the potential for inflation-beating returns. As we have discussed in our post on retirement portfolio construction using buckets, equity MF is a part of the third bucket: How to plan for retirement using the bucket approach?.
High dividend-paying stocks
Priority: Very low
We do not recommend that investors invest in direct stocks due to the research and tracking overhead involved. However, since stock dividends have the potential to provide inflation-indexed returns, you may consider if your parents are comfortable with the extra effort and risk.
Read more here on choosing dividend-paying stocks: How to plan for retirement/FIRE using dividend income?
You should avoid these options at all costs:
- NPS: this scheme is unsuitable for the purpose since the money is locked until the investor turns 60
- Bonds apart from government bonds: an individual investor does not have the means to gauge the risks associated with corporate bonds or NCDs of any issuer. Do not chase yields by investing in state government or state agency bonds or corporate NCDs. The only reason their interest rate is higher than FDs is due to their disproportionately high risk
- Debt mutual funds which invest outside central government bonds or have significant exposure to interest rate risk
A point on taxation
- Tax regime: it is always better to choose a tax regime that minimises taxes. You should use the official income tax calculator to check which tax regime, old or new, is better
- Section 87A: if total income after all allowed deductions is ₹5 lakhs or below, there is no tax on the parent. If there is a slight amount of income that brings the taxable income above 5 lakhs, explore investing in Section 80C eligible options like 5-year-tax-saving FD
“nastiest, hardest problem in finance.” - William Sharpe, Nobel Prize winner, regarding the withdrawal stage of retirement
While this article talks about multiple options for investing, retirement portfolio construction is a bigger problem than “where to invest”. Rather instead, it needs to answer the following three questions:
- is the corpus enough to generate enough retirement income
- will the retirement income be sufficient after inflation and taxes
- what will be the effect of unforeseen events like a health situation that requires long-term care and corresponding expenses
The 3 bucket portfolio, which we have referenced once above, may be used to create such a resilient portfolio.If you liked this article, consider subscribing to new posts by email by filling the form below.
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