How to get a 15% increment every year and retire rich. PMAY is the cherry on the cake!
Dear Taxpayer, If you are earning Rs 12 lakh a year, your total tax should be roughly Rs 1.5 lakh. Despite a tax efficient salary structure, sound investment advice and your own expertise of tax planning, more than 12% of your income would still get eaten up by tax
The higher the income, the higher would be the tax loss. Someone earning Rs 20 lakh would be paying almost 15-18% of his income in tax
The good news is that this tax can be saved by intelligent tax planning. If you buy a house with a loan, the tax savings on the loan interest can help save a neat sum every month. These savings can build a bigger corpus for retirement.
Not planning to buy a house right now?
Sure, there could be several reasons for not buying a house. The economy is slowing down, real estate prices are not rising and home loan interest rates are expected to fall. You may not have surplus money for the downpayment or time to search for a dream home. Or you may have already invested in fixed deposits or land or an under construction property and hence don’t have any money left to buy a house.
But the cost of deferring the decision can be very high. Besides, our calculations show that buying a house will not put too much burden on your finances. Here’s how:
| House price | 3600000 |
| Downpayment (20% of house price) | 720000 |
| Loan (80% of house price) | 2880000 |
| EMI (for 20-year loan at 10%) | 27793 |
| Annual EMI | 333516 |
| Rent received per month | 9000 |
| Estimated savings on tax per month | 8338 |
| Net outflow (EMI-rent-tax savings) | 10455 |
As shown in the tables, the outflow for the buyer is not Rs 27,793. If you take into account the rent received and the tax savings, the net outflow is only Rs 10,455 instead of the actual EMI of Rs 30,506.
The rent and tax savings add up to Rs 17,338 per month. This is nearly 15% of the total income of Rs 12 lakh earned by the taxpayer in a year.
In other words, instead of depending on your employer to hand out a 15% increment this year, you can take the plunge and buy a house to get this 15% increment on your own.
Where will you get the downpayment from?
If you do decide to buy a house, the first hurdle you might face is raising money for the downpayment. If the house is worth Rs 36 lakh, the downpayment must be at least Rs 7,2 lakh (20% of the value of the property). Plus you need additional cash for ancillary expenses such as stamp duty, registration charges and legal fees.
Here are a few possible ways of raising that amount:
- Break tax inefficient fixed deposits: The interest from fixed deposits is fully taxable and is added to the income of the investor and taxed at the applicable rate. In the highest income tax bracket, the post-tax return is not even 5%.
- Surrender low-yield traditional insurance plans: They don’t offer more than 5% returns. These plans also have an investment component so the life insurance cover is very low. Buy a term plan instead to get a high cover at low price.
- Offload gold investments: Gold prices are at all time high levels but may not go up too much from this level. You should consider selling some of your gold holdings to invest in real estate.
- Take loans from relatives: Take money from a relative as a tax-free gift and repay later. Gifts from blood relatives are not taxable.
Withdraw from retirement savings: Subscribers to the EPF and NPS can make partial withdrawals for buying or constructing a house. Though this is not recommended, it can be used as a last resort.
Tax benefits on housing loans
Under Section 24, one can claim tax deduction of up to Rs 2,00,000 interest paid on a housing loan in a financial year. Under the new Section 80EEA, first-time homebuyers with loans of up to Rs 35 lakh can claim an additional deduction of Rs 1.5 lakh for the interest paid provided the value of the house does not exceed Rs 45 lakh. This deduction is over and above the Rs 2 lakh deduction for home loan interest under Section 24.
Interest on housing loan is deductible from rental income. Considering the recommended loan amount, the interest would be higher than rental income resulting in loss from house property. This loss from house property can be adjusted up to Rs 2,00,000 every financial year and the balance can be carried forward for up to eight financial years. This deduction is not dependent on your CTC structure and your employer. Hence, you should definitely avail this to lower your tax outgo significantly.
Don’t buy an under construction house
There is no tax benefit till you get possession of the house. So, if you buy a house that is under construction, the tax outflow will continue. Also, there will obviously be no rental income if the house is under construction. You could face a liquidity crunch because of the EMI outflow with no rent inflow or tax saving.
Advantages of living on rent
We always advise salaried customers to stay in a rented house and give their own house on rent by opting for home loan option. This way they can claim exemption for the house rent allowance (HRA). Another benefit is that you can shift your location as per the demands of your career. If living in a self-owned property, you might not have the freedom to relocate to another part of the city or to a new geography altogether. You might even forgo good career opportunities because you are tied to one location.
Rent not fully taxable and keeps growing
The rental income received from the tenant is not fully taxable. There is a 30% standard deduction on this, which means that if you receive rent of Rs 2,00,000 in a year, only Rs 1,40,000 will be taxed. This provision has been kept towards expenses on repairs and maintenance of the property.
The other benefit is that this rental income keeps growing every year. Rents are usually hiked by 5-10% every year when the rent lease is renewed.
Building an asset with every EMI
A home loan is your SIP in the house. With every EMI you pay, you get to own a part of the house. Over the term of the loan, the entire house becomes yours. In the meantime, the value of the house also appreciates. But this does not affect your EMI outgo, which remains fixed. No other asset can be built by paying only 20% of the value without any enhancement of the asset price. The EMI also instils a saving and investing discipline that helps create a long term asset.
Don’t let savings idle in a bank account
Interest on a saving bank account is exempt up to Rs 10,000 under Sec 80TTA. But this should not make you put a large amount in the bank. Ideally, you should not keep more than three months’ expenses or Rs 2.5 lakh, whichever is lower, in your savings account. The interest is very low at 4%.
Instead of a savings bank account, put your money in a tax efficient mutual fund for liquidity and higher return. Unlike interest income, which is taxed every year, gains from debt funds are taxed only at the time of withdrawal. What’s more, they are taxed at a lower rate of 20% with indexation benefit if held for more than three years.
Don’t sell before five years
Don’t sell the house before five years if you want to avail of the tax benefits. If you sell before five years, the tax benefits will be reversed, which can reduce your gains from the investment. Ideally one should sell rented house property after 5 years to book profit and take capital gain exemption. Alternatively, one can buy a bigger house with the proceeds of the sale to avoid capital gains. You have to invest only the capital gains after indexation. The remaining amount can be diverted to balance the asset portfolio.
How it helps in retire rich?
India does not have a social security system. One can build a big property during one’s earning span of 25-30 years. This property can help generate retirement income for you. Avail reverse mortgage facility for tax free pension against the house you live in. Needless to say the bigger the house, bigger would be tax free pension for you in your golden years.
Do not prepay home loan
Prepaying a home loan may seem a good idea since you save on interest. But if you prepay, the tax benefit gets reduced. It is best to keep the home loan going because you are able to avail of tax benefits that reduce the cost of the loan.
Buy term cover to secure home loan
When you take a home loan, make sure you also take a term plan to cover the outstanding loan. This ensures that the house is with the family even if you are not there. The term cover pays the balance loan to the bank in case of an untoward event. The term cover is better than prepaid insurance offered by banks because they charge for entire tenure of 20 years whereas you might pay off the loan after 5-6 years to reinvest in a new property.
Real estate has potential but is very illiquid
Real estate is a good investment, but is highly illiquid compared to other investments. So, be clear of your goals prior to making investment. If are looking at capital appreciation, stick to residential property. The shortage of quality housing will ensure that the value of your house moves up in the long run, that is if you have made an informed decision. If you want regular returns, invest in commercial property (the returns are around 10-12%). But do not hold on to them for more than 5-7 years as by then the building quality starts deteriorating due to maintenance issues and the investment dips.
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