Start Early To Win The Race
In spite of costly personal loans and zero equity exposure, the Sharma family is ready to get in the groove, says Financial Planner Pankaaj Maalde.
Nishant Sharma, 29, and Sumegha, 26, are newly-weds residing in Pune and both are working in the private sector. Just like other young and 'dinky' (double-income no kids yet) couples, they want to buy a house and a car, and save enough money for their retirement and the higher education of their child. Such couples often have large disposable incomes, but the Sharmas have their financial challenges. Together, they earn `72,000 per month, out of which `35,667 is spent on household expenses and `17,521 has to be paid for the EMIs of three personal loans amounting to `6.5 lakh.
The couple has bought a money-back policy from LIC in 2014 for Rs5 lakh sum assured and also invested in a unit-linked insurance plan (ULIP) in January this year with an annual premium of Rs1 lakh. Additionally, they have purchased a critical illness cover for Rs15 lakh sum assured and the yearly premium is a little over Rs12,000. While too much exposure to insurance has cluttered the scenario, they have little exposure to equity and mostly invested in debt products. They are also paying high interest rates for the ongoing personal loans, leading to negative net worth (see table Assets, Liabilities and Net Worth). But currently, there is no asset available to repay the loan balance. Offloading these liabilities should be their priority as it will allow them to stay within their budget, save more and go for growth investing, especially equity exposure.
The financial road map presented here is based on the information provided by the couple and plan assumptions are listed at the end. It is also assumed that dual income will continue until retirement, but there will be a significant rise in expenses after the birth of a baby two years from now, which will be made good from the rise in income. However, these plans need to be reviewed and reworked periodically, depending on priorities and requirements. An annual review will help the couple stay in control of their finances and work steadily towards their long-time goals.
Getting Started
Emergency fund: Although we do not like it, emergencies do happen. So, one must set aside enough money to cover at least three months' expenses. The current balance of Rs50,000 in the savings bank account and Rs1 lakh investment in debt mutual funds should be allocated for this purpose. As liquidity is the key criterion here, the corpus should be kept in an ultra short-term fund and must not be used for any other purpose. Later on, the couple should save enough to cover six months' expenses.
Life cover: Buying adequate life cover is the next priority. The duo has already purchased a traditional plan and a ULIP, and they pay an annual premium of around Rs1.38 lakh. Considering the present surrender value, future premiums payable and expected maturity value based on current bonus rates, the IRR (internal rate of return) of a traditional LIC plan is unlikely to beat inflation. In fact, it cannot return more than 6 per cent per annum. Hence, they should surrender this plan.
Also, they should not pay any more premium for the ULIP as the charges tend to reduce overall returns. The couple has paid only one premium but when they stop future payments, the policy will lapse and the money will be transferred to a discontinuance policy fund. It will sit there for the entire five-year lock-in period, earning savings bank interest rate (around 4 per cent per annum). Once the tenure is over, the money will be handed over after deducting the discontinuance charge.
As per need-based theory, Sharma and his wife require life cover of Rs1 crore and Rs50 lakh, respectively. So, they should buy two online term plans for 30 years. Put together, they will cost around Rs16,000 a year. Annual premium payouts will also earn tax exemptions under section 80C of the Income Tax Act.
Health and disability covers: Both spouses solely depend on their corporate health cover of Rs4 lakh each. However, it is not advisable to rely only on employer-provided health insurance plans as these will not work after retirement or when people change their jobs. Plus, the benefits may get reduced from year to year. Therefore, Sharma should buy a separate family floater plan for himself and his wife for Rs10 lakh sum assured. It will cost them around Rs14,000 a year. It should be done at the earliest as it becomes more difficult to get new health insurance when one is older. Moreover, some policies may not cover existing medical conditions (if any), or these may be covered after an extended waiting period. Meanwhile, they should continue with the group health insurance policies provided by their respective companies but must port the same to individual policies if and when they leave their current jobs. Discontinue the critical illness plan, though, as health insurance is more crucial at this juncture. Each should buy Rs25 lakh accident disability insurance cover; together, these will cost around Rs6,000 a year.
Premium paid up to Rs25,000 for self and family and an additional Rs30,000 paid for parents will be deducted from the total income u/s 80D of the Income Tax Act. While buying fresh life and health insurance policies, one should always disclose all relevant details, including health history, habits and existing insurance plans.
Planning For The Long Term
The couple has a few specific goals to secure their financial future and also meet some lifestyle needs. To do so, they need to invest more in equity to grow their wealth and do some effective planning to pay off their costly personal loans. The surrender value of the LIC plan should be used to repay the personal loan of Rs1 lakh at the earliest. Using monthly savings of Rs10,000 is also recommended to repay the other two loans faster, in about two years, so that they can service a home loan (see tables Inflow/Outflow and Asset Allocation).
Home purchase: While overexposure to real estate is not desirable, a family should own the house where they live. Buying a home makes a lot of sense if you are spending a lot of money on rental. The couple has already booked their dream home by making a down payment and Rs20 lakh more will be paid to the builder in December 2019. To raise this amount, they should opt for a home loan for 25 years. Assuming the rate of interest at 8.5 per cent, the EMI will be around Rs16,100. Their savings from the rental expense and the current surplus should be adequate to service this loan. As of now, they must focus on this goal alone. A home loans will also reduce their tax liabilities.
Retirement: This is the most crucial long-term goal that no one must ignore. Both spouses are planning to retire at 60, and they require a corpus of Rs4.25 crore, assuming household expenses to be Rs25,000 per month in present value, including 7 per cent inflation, and the life expectancy to be 80 years for both. Current and future investments in the Employees' Provident Fund (EPF) and the Public Provident Fund (PPF, minimum investment required is Rs500 per year) will partly fund this corpus. But they need to start a monthly investment of Rs8,500 via SIP in diversified equity mutual funds to fill the deficit. They can also consider investing in ELSS for tax advantages (see table Retirement Funding).
Child's education: The couple will be planning for a child in about two years and want to fund his/her higher education. To build an education corpus of Rs10 lakh for graduation (in today's value, future value will be Rs40 lakh when the child is 18), they have to start a monthly SIP of Rs5,000 in equity mutual funds. This investment can be started after the personal loans are repaid.
Car Purchase: Finally, they would like to buy a car after a year, which will cost around Rs8 lakh in present value. The goal is not realistic, keeping in mind all existing assets and surpluses. They must buy a less expensive car or go for a pre-used one. This goal should be postponed for years until their incomes increase substantially.
