Challenge Pathway -Prep Book

National Pension Systems (NPS) - PFRDA (Pension Fund) Regulations, 2015 PFRDA (Pension Fund Regulatory and Development Authority) - an autonomous body to develop and regulate the pension sector in India. The National Pension System  Launched on 1st January 2004 under the regulatory framework of the PFRDA  To provide retirement income to all the new government recruits post 1.1.2004.  Replaced the Defined Benefit Pension System that was thus far available to all government employees. In May 2009, the government extended this scheme to all citizens of India including the unorganized sector workers. NPS - National Pension system - A voluntary defined contribution savings scheme designed to enable its subscribers to make regular savings for their retirement throughout their working life. It is a signature scheme of the PFRDA. NPS Scheme details: 1 o An individual can contribute to a pool account managed by PFRDA-authorized fund managers o Fund is managed as per the approved investment guidelines in diversified portfolios of government bonds, listed securities, bills and corporate debentures. o Fund continues to grow with additional contributions and returns generated by the investments o On retirement, the employee may choose to withdraw a lump sum amount and convert the rest of the accumulated corpus into an annuity from an authorized PFRDA empaneled insurance company International College of Financial Planning – Challenge Pathway Prep Book Page 347

PRAN (Permanent Retirement account Number) Mandatory 12 digit number allotted to an NPS subscriber. This number remains with the subscriber throughout this lifetime. He can use this to open and operate both Tier 1 and Tier 2 NPS accounts. On opening an NPS account and on provision of his KYC (Know Your Customer) identification documents, a subscriber is allotted the PRAN. PRAN is useful to track all movements on one’s NPS account – credits, interest accumulation, withdrawals etc. from any location in India. Types of Accounts – Tier-I and Tier-II Tier-I Account (Meant for retirement savings)  Opened by individuals to save funds for retirement  Primary account under NPS  Contributions qualify for tax deductions under section 80CCD (1) and an additional deduction under section 80CCD (1B)  No withdrawals permitted except for special circumstances such as marriage, higher education, purchase or construction of a house, health-related expenses, and disability can one apply for a withdrawal.  Even on retirement, around 60% of the accumulated balance can be commuted – i.e. withdrawn in lump sum. There is no tax applicable on this withdrawal.  The rest of the amount is converted into an annuity which the person receives throughout his retired lifetime. The NPS enjoys several exemptions under the Income Tax Act - E-E-T Contributions Exempt (E) – the contributions to NPS Tier I account are exempt under section 80CCD(1) of the Income Tax Act 1961. There is a further deduction available under section 80CCD(1B) of Rs. 50000. Interest accumulated Exempt (E) - Interest and returns accumulated on the Corpus also exempt on the NPS tier 1 account International College of Financial Planning – Challenge Pathway Prep Book Page 348

Withdrawal partially Taxable (T)- Any amount withdrawn by the subscriber on retirement to the extent of 60% of the accumulated Corpus is tax exempt. The remaining 40% has to compulsorily be used to purchase annuities - Pension received from the fund is Taxable. Any amount received by the nominee on the death of the subscriber is tax exempt. An Exclusive Additional Tax Deduction under Section 80CCD(1B) Section 80CCD (1B) provisions  Tax deductions particularly available to NPS tier I account subscribers.  A subscriber can avail a tax deduction of up to Rs. 1.5 lacs by contributing to the NPS. (total limit clubbed with section 80C)  An additional deduction of Rs. 50000 also made available under section 80CCD (1B). This is over and above the limit of Rs. 1.5 lacs for tax saving under section 80C/80CCD Other Features of the NPS- Low Cost  Effective method of investing in the markets - low expenses and near-zero fund management charges.  The Point of Presence (PoP) may charge certain fees to service the account - such as Initial subscriber registration fees, initial and subsequent contribution charge, Service request charges and Persistency charge  Other charges that may be levied to the subscriber are - central recordkeeping agency charges, investment manager charges, custodian charges and NPS trust charges  The NPS is strictly regulated by the PFRDA (Pension Fund Regulatory and Development Authority)  Accumulation based investment – Contributions to the fund keep accumulating till the retirement of the subscriber. No interest or dividend is paid out from the scheme during the International College of Financial Planning – Challenge Pathway Prep Book Page 349

lifetime of the fund. On retirement, part can be withdrawn in lump sum while the remaining continues to be invested and managed under the fund - annuities are paid out of this amount. Annuity Provisions and Annuity Service Providers (PFRDA empanelled) Annuity is a regular monthly installment payment that the subscriber will receive from the Annuity service provider after his transfer from the NPS account. An Annuity Service Provider is an IRDA (Insurance regulatory and development authority) registered insurance company empanelled by PFRDA for providing Annuity Services. They are responsible for managing the funds and payment of the pension to the subscriber post his retirement. On retirement, at least 40% of the accumulated corpus must be utilized to purchase an annuity. If accumulated amount is less than Rs. 2 lacs, the subscriber can avail complete withdrawal. IRDA approved life insurance companies that can function as Annuity Service Providers – o Life Insurance Corporation of India (LIC) o SBI Life Insurance Co. Ltd (SBI) o ICICI Prudential Life Insurance Co. Ltd o HDFC life insurance co. ltd o Kotak Mahindra Life Insurance company ltd o India First Life Insurance Company Ltd o Star Union Dai-ichi Life Insurance co. ltd. Tier-II Account (Voluntary savings facility) The Tier II NPS account  Second account for more voluntary contribution  Tier I account has to be activated to open Tier II  PRAN number needed to open TIER II account  Minimum Rs. 1000 to be deposited to open the account, subsequent contributions minimum of Rs.250 International College of Financial Planning – Challenge Pathway Prep Book Page 350

 No tax benefits hence the deposits or withdrawals are not tax exempt  No limits on withdrawals and no lock-ins  Separate schemes can be availed in Tier I & II, scheme preference can be changed up to twice in a year  Cheaper investment alternative since the fund management charges are only 0.01% p.a.  NRIs (Non-resident Indians) can also open an NPS tier II account Investment or Portfolio options in NPS - Active and Auto choices Four asset classes to choose from for Tier I and Tier II accounts o Equity (Asset Class E) o Corporate Debt (Asset Class C) o Government Securities(Asset Class G) o Alternative investments (Asset Class A) such as REITs (Real Estate Investment Trusts), AIFs (Alternative Investment funds), CMBSs (Commercial Mortgage Backed securities) Two investment options available at the time of applying for the NPS- Active Choice and Auto Choice Active Choice The subscriber can choose to invest either in equities, corporate bonds or Government securities. Investment in equity is restricted to 75% of the corpus, the investment in corporate bonds and government securities can go up to 100%. Auto Choice The asset allocation of the subscriber’s fund follows life-cycle based approach reducing the allocation to equities with the subscriber’s increasing age. Subscriber can choose one of the three options for Life Cycle– International College of Financial Planning – Challenge Pathway Prep Book Page 351

Conservative Equity exposure maximum 25% Moderate Equity exposure maximum 50% Aggressive Equity exposure maximum 75% Point of Presence (POP) Service Provider The Point of Presence (PoP) service providers - Initial points of contact for any subscriber wanting to activate an NPS account. The authorized branches of the POP act as collection points providing customer service for the system. Service requests processed by PoPs-  Acceptance of forms for fresh subscription  Verification and processing of KYC & nomination requests  Processing of forms for the CRA  Record and process initial and subsequent contributions, withdrawals  Record and process changes in subscriber details  Handling various grievances and routing them to the various NPS intermediaries. Central Record-keeping Agency (CRA) Central record-keeping agency A centralized authority appointed by the PFRDA that enables the functioning of the NPS. CRAs for NPS -  NSDL e-Governance Infrastructure limited  K-Fin Technologies Private limited The CRA acts as an important interface between the various intermediaries of the NPS framework – the PFRDA, NPS trust, annuity service providers, fund managers, trustee banks etc. International College of Financial Planning – Challenge Pathway Prep Book Page 352

Functions of the CRA-  Registration of subscribers and issuance of the PRAN, dispatch of the PRAN card and welcome kit  Maintenance, inundation, monitoring of subscriber records  Dispatch of statements of accounts to the subscribers and providing them with online access to their accounts  Processing of exit/withdrawal and other such service requests  Receipt and address of subscriber complaints The CRA operates via the CRA-FC (Facilitation centers) and are regulated by the PFRDA (Central Recordkeeping Agency) regulations, 2015 There are 7 pension fund managers impanelled with the NPS - Fund manager can be changed once in a financial year. SBI, LIC & UTI are the only fund managers that can manage the contributions of the government employees under the NPS. NPS Trust  NPS Trust was established by the PFRDA (Pension Fund Regulatory and Development Authority) under the Indian Trusts Act 1882  Board of trustees are responsible to take care of the funds of the NPS. Board of trustees have legal ownership over the trust’s funds.  Authorized by the PFRDA to carry out a monthly operational audit of the intermediaries such as the pension fund managers and also evaluate the performance of the appointed agencies every quarter. International College of Financial Planning – Challenge Pathway Prep Book Page 353

Functions of the board of Trustees of the NPS Trust  Execute the individual account holder’s pension account  Approve and monitor audit reports, financial statements, compliance reports etc.  Monitor and evaluate all operational activities and service level agreements as carried out by the various appointed intermediate agencies.  Protect and safeguard the interest of the subscribers  Address of subscriber grievances and complaints  Supervise the collection of any income due to the trust funds and claim any repayments from tax. Trustee Bank What is a Trustee Bank The NPS Trust holds an account with a bank that is responsible for all Trust fund related activities – deposits, withdrawals, pension disbursal. This is called a Trustee Bank. Functions of the trustee bank  Responsible for the day-to-day fund flow and other banking activities of the NPS Trust  Receives funds from all nodal offices and redirects them to the pension fund managers/annuity services providers.  Transfers funds to various entities during the settlement process  Provides periodic reports for the review and audit related activities of the trust. Who is a Retirement Adviser (RA) o Any person who desires to provide retirement advisory services on the National Pension System or any other such pension scheme regulated by the PFRDA. o The applicant has to make an application online on the PFRDA website by submitting his documents. o He will then be allotted a certificate to operate as a retirement adviser for three years International College of Financial Planning – Challenge Pathway Prep Book Page 354

o Fresh certification or renewal is required to be done through completing continuous professional education o Can charge a fee to their clients with a written agreement o They are regulated by the PFRDA via their operational guidelines. Role of the Retirement adviser o Advise prospective subscribers on the procedure of enrolment o Bring in subscribers on the NPS platform o Create awareness about NPS and other such retirement related schemes o Help subscribers plan retirement savings. o Carry out due diligence on the prospective subscriber o Carry out retirement and financial planning of the subscriber - identifying the goals, analyzing the current financial situation, profiling the risk appetite, deriving the asset allocation, suggesting the appropriate investment allocation, periodic monitoring and rebalancing of the strategy o Guide on the advised asset allocation and choice of underlying asset classes at various ages and stage of life o Advise and create awareness about the performance of the pension funds o Run awareness programs on retirement planning NPS-Lite Introduced to serve the interests of the Low Income Group subscribers who are economically disadvantaged and cannot bear heavy charges on their investment accounts Aggregator The link between the subscriber and the NPS-lite system International College of Financial Planning – Challenge Pathway Prep Book Page 355

Functions of an aggregator Part of a group servicing endeavour to reach out to and service low income citizens. Contact point for subscriber service requests. Examples of aggregators - Axis Bank, Allahabad Bank, Bank Of Maharashtra, LIC housing finance limited, Jagran Microfin Pvt ltd etc. NPS Models There are 4 different types of models/variants of the NPS system - o All Citizen Model o Government Sector Model o Corporate Model o NPS Swavlamban/ NPS Lite/ Atal Pension Yojana All Citizen Model It is for the common citizens of the country, not dependent upon the government for their financial support or salary. E.g.: self-employed individuals, professionals, business owners etc. The Central government had initially issued the NPS for the government employees in 2004. In 2009, the NPS was made available to all citizens of India.  Resident or NRI  Between 18 to 65 years of age Government Model For the Central and State Government employees who receive their pension post retirement from the government Except for the Armed Forces, it applies to all government employees who joined service after 1st January, 2004. International College of Financial Planning – Challenge Pathway Prep Book Page 356

Under the government model, the employee contributes 10% of his salary to the pension fund with a matching contribution from the government. From 01.04.2019, the employer’s contribution has been enhanced to 14% in case of central Government employees. Corporate Model Applies to the Corporate sector employees - Any entity registered under the companies Act, cooperative act, Central or state Public sector enterprises, partnership firm, LLP, trust or Proprietorship firm may join the NPS. The employees of the entity will be registered with the NPS Trust as subscribers. The rights of subscribers under the corporate model remain intact The employer can co-contribute to the employees’ pension funds and claim this as a business expense in their tax filing. No compulsory contributions from either employer or employee into the fund Atal Pension Yojana (APY)  For the socio-economically disadvantaged, low income group citizens  Between the ages of 18 to 40 years. The age of exit/start of pension is 60 years -so minimum period of contribution has to be 20 years.  Who receive support from the government as a share in their pension contributions  Government guarantees a monthly pension in the range of Rs. 1000- Rs. 5000  The subscriber can choose the amount of pension required on retirement and the contributions can be adjusted accordingly.  For those who are not covered under any social security scheme and not Income Tax payers, the government also co-contributes 50% of the subscriber’s contribution to the NPS subject to a maximum of Rs. 1000 per annum.  The scheme is administered by the PFRDA under the NPS framework.  PFRDA chooses the pension funds as specified by the government. International College of Financial Planning – Challenge Pathway Prep Book Page 357

 No option for the subscriber to choose the investment pattern or the pension fund. The PPF or the Public Provident Fund: One of the most widely used voluntary institutional retirement products, tax- cum- savings instrument in the country. o A long term savings and tax planning option o Sovereign guaranteed o Available to Indian resident citizens only o Set up under the Public Provident fund act 1968 and changed into the Public Provident fund Act 2019 o Enables subscribers to save some amount annually o The corpus gathers interest for a long period of time o Corpus with interest becomes eligible for redemption after a set period, with few exceptions for premature withdrawal. o As on 2020, interest rate on the PPF account is 7.1% p.a. o Interest accrued is tax free on accrual and redemption The Department of Economic Affairs, under the purview of the Finance Ministry runs the PPF framework.  PPF account can be opened with any nationalized public/private sector bank/post office.  The subscriber is issued a passbook/statement of account like a normal bank account wherein all his deposits, withdrawals, interest credits, loans, repayments etc. are recorded.  All service requests are handled via the account opening office. The following individuals are eligible to open accounts under PPF – Resident Indian individuals Minors with a resident Indian individual as the guardian  The minimum subscription amount in a PPF is Rs. 500 International College of Financial Planning – Challenge Pathway Prep Book Page 358

 The maximum is Rs. 1,50,000/- per annum.  The deposits should be in multiples of Rs. 50.  The interest is calculated on the lowest outstanding on the fund between the 5th and the last day of the month.  Deposits more than Rs. 1.5 lacs in a financial year are considered an irregular investment and refunded to the subscriber without any interest or tax exemption.  A subscriber can have only one PPF account at a time.  Minimum tenure of 15 years  Withdrawals not allowed apart from specific conditions.  Post 5 years of account opening and contributing, the account can be closed for medical or higher education reasons  Can be done only post 7 years of the initial 15 years period  Withdrawal can be made only once in a financial year. Partial withdrawal is restricted to - Half of the closing balance at the end of the 4th year before the year in which the money is being withdrawn OR 50% of the closing balance of the previous year.  Loan facility available only between the 3rd and 6th year of the initial 15-year tenure  The interest charged on the loan is 1% p.a.  The principal borrowed on the loan has to be repaid within 36 months  The accrued interest has to be paid within two monthly installments post the repayment of principal.  If the repayment is not done within 36 months, then the interest charged on the loan would go up to 6% p.a.  The fund borrowed does not earn any interest, during the tenure of the loan Maturity Profile of PPF After 15 years - account can be extended in blocks of 5 years any number of times Rollover/ extension of the fund can be done with or without further subscription International College of Financial Planning – Challenge Pathway Prep Book Page 359

Rollover With further subscription Form 15H to be submitted to the bank/post office. 60% of the accumulated corpus can be withdrawn during the extended period, but only once during a financial year Rollover Without further subscription If no option exercised till 1 year, it is deemed to be extended without subscription for 5 years. Option cannot be changed to \"with subscription\" Entire outstanding amount can be withdrawn during extended period, but only once during a financial year Viability of PPF Scheme – A Credible Aggregator of Retirement Corpus  Relatively secure investment  Tax saving  Debt oriented offering a fixed interest rate, determined by the government  Sovereign guaranteed  interest on the outstanding investments calculated on compounded basis  Corpus multiplies at a steady inflation-adjusted pace.  Cannot be attached by the courts if a litigation goes against the subscriber  No upper limit on the age of opening the PPF account.  A minor can also have a PPF account Pension Plans from Mutual Funds and Insurance Companies Mutual funds and Insurance companies provide pension’s plans as retirement solutions to their customers International College of Financial Planning – Challenge Pathway Prep Book Page 360

 Mix of equity and debt oriented investments  Serve as tax and savings plan  Encourage savings in working life for retirement The SEBI re-categorization of mutual funds in 2018 opened up a new category called solution oriented scheme schemes in mutual funds. Lock-in period is 5 years or retirement whichever is earlier. On completion of lock-in, one can withdraw lump sum/take annuity payments in the form of a Systematic withdrawal plan (SWP). Some schemes also have a high exit load for a period of 5 years An Annuity is defined as a regular pay out from the pension fund for monthly expenses. Pension schemes from mutual funds do not provide annuity – one can choose the option to take a systematic withdrawal (SWP) from the scheme. Systematic Withdrawal Plan A specified amount can be withdrawn every month from the accumulated corpus as SWP – this is akin to having an annuity payment coming in every month from the pension fund. Benefits of an SWP over an annuity  One’s capital invested is a major part of the amount withdrawn – hence the tax payable is lower since profit is a small portion of the withdrawn amount in initial years  Annuity is taxed at marginal rate. Capital gains are taxed lower at flat rates.  Benefit of up to Rs. 1 lac exemption on capital gains in the financial year. Pension Plans from insurance companies  Insurance-cum-investment plans help subscribers gather a corpus during their working life International College of Financial Planning – Challenge Pathway Prep Book Page 361

 Investment grows till retirement and provides annuity income post retirement Two types of pension plans Immediate annuity - wherein the policyholder begins to receive annuity payments immediately after depositing a certain lump sum Deferred annuity - wherein the policyholder receives an annuity after a certain number of years on the policy. One can choose to invest one’s corpus in market linked or a conventional fixed income plan. Market-linked investments from insurance plans are called Unit Linked. These monies are invested in the market to the extent specified by the investor by his choice of plan, continue to appreciate and bear market volatility like normal equity-linked investments Locked in for a period of 5 years with no option to withdraw the policy either partially or wholly. Mortality Charges: Charges for covering the life risk of the insured from the policy In a ULIP, these charges are deducted in the form of units being cancelled from the accumulated corpus every month. Death of Insured During policy term: nominee is eligible to receive the sum assured. Post retirement: nominee has an option to take the death benefit as a lump sum or annuity purchase Premiums paid: Deductible under section 80CCC of the Income Tax Act 1961 , maximum permissible limit of Rs. 1.5 lacs as part of section 80C Amount Commuted on vesting age: Choice to commute up to 60% of the accumulated corpus which is tax -exempt International College of Financial Planning – Challenge Pathway Prep Book Page 362

Annuity from remaining amount: Added to the Gross taxable income and taxed at the marginal slab rate of tax. Death Benefit Received by Nominee: Lump-sum : Tax free , Annuity: Nominee’s slab rate Surrender of Policy: Tax benefits under section 80C on the premium payments added back to income and charged to tax. In case of no tax benefits being availed, returns earned on the policy are charged to tax Lock-in period The policy is locked in for a period of 5 years from inception. No partial or whole withdrawals are allowed. Post 5 years, the policy holder can withdraw up to 25% each time up to 3 times during the policy term At the time of vesting, the policyholder can decide to commute into 60% of his policy value and the remainder has to be used to purchase an annuity Annuities IRDAI - Insurance Regulatory and Development Authority of India Autonomous body set up by the government of India under the IRDA Act 1999 to promote the insurance industry in India and protect the interests of the policyholders. There are 24 Life insurers currently registered under the IRDAI offering pension policies. Annuity A life policy where the policyholder can gather funds in lump sum or instalments, grow the funds throughout his working lifetime and receive a steady income post retirement. International College of Financial Planning – Challenge Pathway Prep Book Page 363

This policy also provides a life cover. Hence is an insurance policy –cum- retirement savings option Minimum annuity for an individual in a year is Rs. 12000 which is Rs. 1000 per month. No maximum limits to this amount. Complete withdrawal of accumulated corpus on reaching retirement age, if minimum annuity of Rs. 1000 cannot be provided from the policy. In case of immediate annuity, an amount which ensures minimum monthly annuity payment of Rs. 1000 is permissible as the lump sum single premium. To secure the older citizens of the country, the government has introduced and implemented several schemes in order to provide regular income and support to its senior population-  Senior citizen savings Scheme (SCSS)  Post Office Monthly Income Scheme (POMIS) Senior Citizens Savings Scheme (SCSS) Run by the Government of India as a sovereign guaranteed monthly income scheme for its senior citizens aged above 60 years. The rate of interest on the scheme is also fixed by the government. Page 364 International College of Financial Planning – Challenge Pathway Prep Book

Features of the SCSS  Minimum deposit is Rs. 1000 and the deposit has to be in multiples of Rs. 1000. The upper limit is Rs. 15 lacs  Only one deposit per account – only lump sums are allowed.  For further deposits, new accounts need to be opened.  No age limit applicable for the second applicant.  Designated Private and Public sector banks and post offices offer this facility.  Combined deposits cannot exceed Rs. 15 lacs.  Maturity period of 5 years extendable upto 3 years. The extension request has to be made within 1 year of the completion of the first 5 years.  Individuals below the age of 60 retired early after the age of 55 under the VRS (voluntary retirement scheme) or Superannuation scheme can also open an SCSS account.  Retired defence personnel can open this account irrespective of the age limit.  NRIs, PIOs and HUFs are not eligible to open this account.  The deposits eligible for tax deduction under section 80C up to a limit of Rs. 1.5 lacs.  The interest on the SCSS is fully taxable.  The interest is paid out quarterly directly into the depositor’s account Premature withdrawal rules  After 1 year before 2 years of starting the deposit scheme- penalty of 1.5% of the withdrawn amount  After 2 years before 5 years of starting the deposit scheme- penalty of 1% of the withdrawn amount  Post extension - anytime without penalty after 1 year of extension of the withdrawn amount Post Office Monthly Income Scheme (POMIS) Post offices run monthly income schemes (POMIS) recognized by the Ministry of Finance that can be used by Senior citizens to garner a scheduled monthly payment over their retirement years International College of Financial Planning – Challenge Pathway Prep Book Page 365

The rate currently being offered is 6.6% p.a. Features of a post office MIS (POMIS) -  The investment period is 5 years  Monthly interest pay out  5 year lock in  Upper limit of Rs. 4.5 lacs of deposit across all POMIS accounts combined, lower limit of Rs. 1500  The maximum limit under a joint account is Rs. 9 lacs. The amount has to be in multiples of Rs. 1000  Maximum of 3 joint holders  NRIs not eligible  No TDS deducted on the interest payments  Minor account allowed – upper limit Rs. 3 lacs of deposit Premature withdrawals o Not allowed up to 1 year o Between 1 and 3 years - the penalty is 2% of the withdrawn amount o Between 3 and 5 years, the penalty is 1% of the withdrawn amount Reverse mortgage A financial product that enables senior citizens who are above the age of 60, to apply for a mortgage of their self-owned property with a lender and receive tax free income without having to sell the house during their lifetime. The citizen availing the Mortgage continues to remain the owner of the house till her/his lifetime. Primary lending institutions (PLIs), housing Finance companies (HFCs) and other such notified lenders registered with the National Housing Bank are allowed to issue reverse mortgage loans International College of Financial Planning – Challenge Pathway Prep Book Page 366

Rules of Reverse Mortgage  Citizen applying has to be at least 60 years of age  The loan amount depends upon the value of the house, the age of the citizen and the prevailing interest rate  The citizen has to be the owner of the property and it has to be free from encumbrances  Only residential properties can be reverse mortgaged  Purpose of loan can be purchase/construction of a house property, medical emergencies, supplementing of retirement/pension income etc.  Purpose of the loan cannot be trading, business or speculative  The valuation of the property is done whenever the lender deems fit, at least once in 5 years  Valuation done by an externally appointed approved valuer.  Quantum of the loan can be reduced in case of reduction in the value of the property.  The lender pays monthly amounts to the borrowing senior citizens  Maximum loan tenure is 20 years  Loan not required to be serviced during the lifetime of the owner  Non-recourse loan - the lender cannot ask the borrower for more than the net realizable value of the property  Post the owner’s death, the house mortgaged is sold and the loan monies are recovered  Spouse continues to stay in the property and receive monthly payments till he/she is alive or the end of the loan tenure  After the tenure of the loan is over, there are multiple methods to repay the loan in lump sum.  The borrower can choose to prepay the loan and there is no prepayment penalty charged to him  The payments given by the lender are exempt under income tax  The settlement of the loan can be done when the last surviving spouse passes away or relocates.  The home-owner/heirs have the first right to settle the loan without selling the property.  Balance post settlement of principal and interest accrued is passed on to the beneficiaries. International College of Financial Planning – Challenge Pathway Prep Book Page 367

Regulator for Reverse Mortgage Scheme: National Housing Bank The regulator for the reverse mortgage scheme is the NHB (National Housing Bank) NHB was setup in 1988 by the Government of India The headquarters are in New Delhi with regional offices in the major cities of India NHB primarily operates as a principal agency to promote housing finance institutions at both local and regional levels and provide financial and other support to related institutions. RMLeA (Reverse Mortgage Loan Enabled annuity)  For senior citizens in India who wish to utilize the equity in their owned residential property and gain a regular income stream from the value of the property without selling it.  Scheduled Commercial Banks and Housing Finance Companies are eligible to run this scheme for borrowers  Regulation under the NHB (National Housing Board  Annuity payments are for a lifetime and not restricted to 20 years as under the conventional RML.  The annuity payments are designed and executed by two entities currently – Star Union Dai-ichi Life Insurance Company limited and Central Bank of India. o Lump sum payments can be made for medical emergencies  Maximum limit up to 25% of eligible loan value  Limit of Rs. 15 lacs International College of Financial Planning – Challenge Pathway Prep Book Page 368

 The primary lending institution has to ensure the surviving status of the borrowers and keep the insurance company informed.  The annuity payments subject to tax in the hands of the recipient.  The lending institution may charge ongoing service charges, origination and inspection fees, property and title verification fees, other legal charges and fees, survey and property valuation charges etc. to the borrower during the course of the loan tenure.  The loan can be settled only once the last surviving spouse passed away or wishes to sell or relocate from the property. The conditions to avail the RMLeA o The residual life of the property must be at least 20 years o The prospective borrower must be using the pledged property as his/her primary residence. o The minimum value of the property must not be below Rs. 5 lacs Quantum of loan eligibility is as per age Age of Borrower Maximum Loan to Value Ratio Between 60 and 70 60% Between 70 and 80 70% 80 and above 75% The annuity paid out will also differ as per the option chosen –  RMLeA without return of purchase price (option 1) and  RMLeA with return of purchase price (option 2). RMLeA without return of purchase price On death of the borrower, the joint borrower can purchase a separate lifetime annuity since the annuity on the original RMLeA is payable only until the demise of the primary borrower. International College of Financial Planning – Challenge Pathway Prep Book Page 369

RMLeA with return of purchase price On death of the primary borrower, the surviving borrower continues to receive annuity payments Retirement Cash Flow, Withdrawal Projections and Strategies Income is generated by dividends or interest. That’s not a problem, but it does present a limitation. Cash flow, on the other hand, can come from dividends and interest, along with resources generated from the sale of assets. Cash flow provides a more broad-based source from which to generate payments to the retiree, and is preferable to use in retirement planning. Increased longevity provides much more opportunity for retirees to run out of money. The solution to proving adequate cash flow and protecting against running out of money is either to accumulate very large sums or to keep as large a portion of accumulated assets as possible invested, while gradually liquidating amounts needed to provide cash flow. The longer-term investments can help offset purchasing power problems related to increased longevity. Studies indicate that increasing portfolio equity percentages (to a point) has a significantly positive impact on initial withdrawal rates and subsequent withdrawals, as well as overall portfolio sustainability. This should come as no real surprise to even a casual student of investments. However, it is contrary to what many still consider to be the correct way to structure a retirement portfolio. That is, the percentage of fixed income and cash investments should be immediately and significantly increased upon entering retirement. A better approach appears to be moving the year’s required cash flow/withdrawals into cash, and leaving the rest of the portfolio invested in whatever allocation the client has chosen. International College of Financial Planning – Challenge Pathway Prep Book Page 370

Lifetime income: This pool is designed to provide guaranteed income for life. All capital will be depleted by the time of death. Any source, such as annuities, that can provide a guaranteed income stream fits into this pool. Preserved capital: This pool is a traditional investment portfolio holding stocks, bonds, and any other appropriate securities. This, too, is designed to contribute to cash flow for the retiree’s life. However, unlike the first pool, the retiree likely does not plan to fully deplete all capital, and plans to leave any remainder to heirs or other beneficiaries. Medical reserve: We have discussed the potential impact medical expense can have on a retiree’s cash flow. This pool is a fund that can be reserved to meet excess medical costs that may occur as the retiree ages. In addition to portfolio assets, this pool may include long-term care or other insurance to cover medical expenses. Capital consumption: This pool is set aside to provide additional cash flow by drawing down capital. Since cash flow will be generated not only by interest payments, or other income-generating investments, but also by depleting principal or capital, this pool can have a large positive impact on cash flow (recognizing that when the money is gone, there will be neither earnings nor cash flow generation). There are actually two pool categories in this section: The first pool typically takes money from the second pool to purchase an immediate annuity. The second pool is a holding place for any capital not being used by the other pools. These funds can be used for things like travel, gifts, charitable contributions, and similar. What can clients do to control or reduce taxation? If we accept that income taxes can be a – sometimes significant – drain on retirement cash flow, what can clients do to control or reduce taxation? The most obvious solution is to place assets into non-taxable savings/investment vehicles. Many territories have vehicles with earning that are not subject to income tax. International College of Financial Planning – Challenge Pathway Prep Book Page 371

Some retirement plan distributions have no income tax, while others are taxed, but on a reduced basis. When building a retirement portfolio, the financial advisor and client should consider the future taxability of asset location – within or outside of retirement accounts. Distributions from these may be fully taxed, partially taxed, or tax free. International College of Financial Planning – Challenge Pathway Prep Book Page 372

TAXATION International College of Financial Planning – Challenge Pathway Prep Book Page 373

International College of Financial Planning – Challenge Pathway Prep Book Page 374

International Taxation Types of Taxes to Which Individuals Are Subject INCOME TAX: These are government (national, regional, and local) taxes on earned income. VALUE ADDED TAX (VAT): These are a type of consumption tax placed on each step of the production process and also collected when the product is sold. Tax rates vary by product or service, and by territory, ranging from less than 10% to 20% or slightly more. Most developed territories levy a VAT in some form. SALES TAX: These taxes are imposed by a government (national, regional, local, or other) at the point of sale. Retail goods and services may be taxed. Sales taxes are not the same as VAT. The biggest difference being that sales taxes are collected from consumers at the time of sale, while VAT are collected throughout the supply chain along each step of the production process. PROPERTY TAX: These are assessed on real property. The amount of tax usually depends on the assessed value of the property. EXCISE TAX: These are normally assessed by the government on particular products. Excise taxes may be ad valorem—a fixed percentage charged on a specific good, or specific—a fixed amount based on the quantity purchased. WEALTH DISTRIBUTION TAX: These are taxes imposed by governments on the distribution of estate assets. INCOME TAX TERMS ADJUSTMENTS TO INCOME: These are any items that increase or decrease income. Penalties and interest on taxes owed, but not paid, are examples of adjustments that increase income. Adjustments International College of Financial Planning – Challenge Pathway Prep Book Page 375

that decrease income include all exemptions and deductions that one could apply. The specific elements will vary by territory, but may include items such as education expenses, contributions to retirement plans, expenses related to children, etc. An exemption eliminates income from inclusion in the tax computation. A deduction provides a credit against qualified expenses, such as those for childcare or education. ADJUSTED TOTAL INCOME/GROSS INCOME: The amount of reportable income after making applicable adjustments to income. FILING STATUS: Indicates for tax purposes whether a person is married or single, with or without dependent children, etc... MARGINAL TAX BRACKET: In a progressive or banded tax scheme, it is the rate of tax the individual pays on the highest amount of taxable income (e.g., X + 1). PHASEOUTS: Some deductions or exemptions may only be available below certain income thresholds. When income increases above the threshold, the deduction may be phased out, based on exactly how much income the individual earns. There will likely come a point where the deduction is fully eliminated, because income is too high to qualify. TAX CREDIT: Reduces actual taxes owed based on criteria built into the tax code. This is different than a tax deduction, which is applied against expenses. A tax credit actually reduces the tax owed. For example, suppose a person calculates his or her tax payment to be $10,000. The taxes would have been calculated after subtracting all adjustments to income. If that person is eligible for a $1,000 tax credit, he or she now only owes $9,000 in taxes. Tax credits, where available, can be very beneficial. TAX AVOIDANCE: Legally reducing taxes based on application of proper tax strategies. Most courts of law recognize a taxpayer’s right to minimize through use of legal tax planning opportunities. Financial planners should exercise caution by recognizing that a tax-reduction technique that is legal in one territory may not be viewed as legal in another. International College of Financial Planning – Challenge Pathway Prep Book Page 376

TAX DEFERRAL: Delaying payment of taxes. This is not the same as tax avoidance, where taxes are never paid on a certain amount of income. Deferral simply delays payment to a later date. For example, some territories allow tax deferral on earnings within certain investment vehicles used for retirement. TAX RETURN : The official document(s) used to report income and related taxes. TAX TREATY: An agreement between territories regarding how taxes will be assessed on income earned in one or the other territory, especially when a company or citizen domiciled in one territory earns income in another territory. TOTAL INCOME: Sometimes called gross income. This is income, unless otherwise excluded, from any and all sources. Note that total income may not actually refer to all income. Instead, it refers to all income that is counted or not excluded for tax purposes. Income that is excluded does not increase a person’s potential tax liability. Basic Income Tax Strategies One strategy is to evaluate whether a person would be better off financially reducing, deferring, or shifting income to either preserve valuable tax deductions or stay within a particular tax rate band. Social security/benefit payments can be included in the income tax category. Some territories levy a large percentage social insurance tax on employees, while others do not. The degree of taxation is not necessarily directly caused by the amount of benefits likely to be received by the employee at some point in the future, but there is, of course, a relationship. Territories with higher levels of social security benefits generally levy higher percentages of taxation, while territories at the opposite end of the spectrum generally levy fewer taxes. Tax filing status is another area to consider. A few territories assess a flat tax regardless of filing status. This means that it doesn’t matter whether the individual is single or married, divorced or separated, International College of Financial Planning – Challenge Pathway Prep Book Page 377

with or without children, a widow(er), high or low income, or has some other status. In other territories, however, filing status can make a big difference in tax rates.  For example, income or maintenance payments to a former spouse may be deductible to the payor depending on the territory and whether the individuals are legally divorced or simply separated and living apart.  Similarly, a single person with children at home may have a different filing status than one without dependent children. Where applicable, financial planners would do well to investigate whether clients filing a tax return with a different legal status (e.g., married, single, etc.) would make a difference in the amount of tax he or she owes. Property-Related Taxes Income taxation can be clear-cut, with fairly simple strategic planning opportunities. However, as a client moves higher on the income and/or asset scale, he or she may have greater strategic opportunities, such as shifting or deferring income. Individuals with greater assets and/or higher income often have more options to address potential tax liabilities. We will focus on the circumstances of the “average” person. Average, of course, will vary greatly by territory and situation. A person considered to have a modest level of income or assets in one territory may be considered wealthy (or poor) in another. Throughout this course, we will attempt to strike a balance that will be applicable in most areas. Categories of Property Proper categorization can make a difference in how to treat the item for tax purposes. Below are three distinct categories of property: International College of Financial Planning – Challenge Pathway Prep Book Page 378

Personal Property Personal property includes such items as: household furnishings, jewelry, artwork, clothing, computers, cars, and similar. One way to identify personal property is that it can be moved. Personal property also often is categorized as use property. Personal use property is different from investment property. Investment property is purchased and held for the specific purpose of selling it to make a profit. The determination of whether a piece of property should be categorized in the personal use or investment category can become a little cloudy. For example: A painting may be considered a use asset—simply a decoration on the wall—until it is sold at a profit, at which point it may be categorized as an investment. A coin collection may represent an enjoyable hobby and considered a use asset until it is part of a profitable sale. At that point it would almost certainly be reclassified as an investment. Correct categorization of personal property matters, because tax codes often treat the sale of personal use assets (i.e., most personal property) differently than an investment sale. Most purchases or sales of personal use assets do not represent a taxable event. That is, no tax consequences exist either at time of purchase or sale (beyond possible sales tax or VAT). As a financial planner, you should know that often, but not always, the taxing authority determines an asset’s status as either use or investment. Sometimes, though, the individual can make a cogent argument that the asset’s status should be one or the other, and the taxing authority accepts the argument. As a result, it’s often beneficial to at least consider making a case if the initial determination is less advantageous than anticipated. Real Property Authorities sometimes tax real property in a different manner than personal use or various types of investment property. Owners of real property often pay taxes on an annual basis, in addition to when they sell the property. We should note, however, that not all territories assess an annual property tax . Taxation is based on the current value of the property, and characteristically is assessed for the benefit of the community. For example, property taxes may be used to help maintain roads, build schools, or support the local government. International College of Financial Planning – Challenge Pathway Prep Book Page 379

Taxes usually are based on a current appraisal, so it makes sense to ensure an accurate valuation. Depending on the territory, real property used for investment purposes may be taxed differently than property at which the owner resides. Territories sometimes give tax incentives for home ownership that are not available to investment-related real property. Territories often develop tax legislation to encourage or discourage various actions. For example, if a territory wants to encourage savings and investment, it may provide tax incentives to do so. Many territories wish to promote home ownership in one form or another. This is why certain tax incentives, such as a partial (or full) deduction for mortgage interest paid, may be introduced. Investment Property Investment properties, or non-real property securities, often have tax characteristics that differ from other property. This is one reason why it’s important to correctly differentiate between personal use property and that which someone holds for investment purposes. Simply put, people purchase investments to make money. Investment return primarily comprises some combination of income and capital or asset appreciation. Investment income usually is categorized as unearned rather than earned, which is how wages and other employment-related income are categorized. Unearned, or investment, income may or may not receive tax treatment that differs from earned income. Bonds and dividend-paying stocks often generate unearned income. Investment real estate also may produce unearned income. Royalties originate from an arrangement where an entity (e.g., individual, corporation, trust, government) pays another entity for the right to use an asset. These arrangements may be applied to any number of situations and an entity may receive royalties from allowing the use of (for example): o Mineral or petroleum resources o Patents o Trademarks o Franchises International College of Financial Planning – Challenge Pathway Prep Book Page 380

o Copyrights o Book publishing o Music Performance o Intellectual property Capital Assets: Gains and Losses A capital asset is property used to generate a financial return, rather than property used generally for consumption or put to other personal use. o A realized capital gain or loss is a gain or loss that results when a person sells the asset. It is realized because the owner actually receives the results of the sale—either for a gain or a loss. o Unrealized gains or losses may happen when the owner does not sell the asset. An increase/decrease in the value of a stock in a portfolio is an example of an unrealized gain/loss. o The stock has increased (or decreased) in price or value, but the investor has not sold the stock or received any money, so he or she has not realized any gain or loss. Nonetheless, unrealized gains sometimes may be taxable. o Short-term or long-term gains or losses are a little more difficult. Both refer to the length of time a person holds a capital asset. o As a general rule, shares held for one year or more often are treated as producing long-term capital gains or losses. o Shares held for less than one year often will be treated as producing short-term gains or losses. o Strategically, if the holding period makes a potential difference in tax rates, the individual might want to consider delaying a sale so as to qualify for the longer holding period treatment. Basis Basis is the adjusted cost of the property. Adjustments can either increase or decrease basis. For example, in territories that have a depreciation allowance, amounts claimed typically will decrease the cost basis. International College of Financial Planning – Challenge Pathway Prep Book Page 381

On the other hand, if an investor is required to pay additional funds to improve the asset (e.g., to paint or improve rental real estate or repair an investment asset), those expenses may serve to increase the cost basis. Although investment property may be treated differently depending on its nature (capital asset or other), holding period (short- or long-term), status (still within a portfolio or sold), or territory, one factor is consistent: The property owner must be able to identify what was paid to purchase the asset and the price he or she received when the asset is sold. People normally pay taxes on investment-related gain. The current value or sales price is easy to know. Example 1: An investment purchased for $100 has an initial cost basis of $100. If that asset sells for $100, with no supplementary funding added or expenses subtracted, there is no gain or loss, and (most likely) the owner won’t pay tax on the sale. However, let’s assume the investor had to improve the asset at a cost of $50. Now, the asset has a cost basis of $150. If the asset sells for $150 after the additional investment, all things being equal, there should be no taxable gain on the sale. In the same situation, if the asset sells for $200, the investor will potentially have a taxable gain of $50. Example 2: An investor invested $1,000 in mutual fund shares at a price of $10 per share two years ago (100 shares), $1,000 at a price of $8 per share one year ago (125 shares), and $1,000 at a price of $5 per share six months ago (200 shares). Assume the investor wants to withdraw $1,000 today when the share price is $10 (i.e., 100 shares). The answer depends on whether shares are arbitrarily withdrawn from the entire basket of shares or if the investor can identify specific shares to be withdrawn. If shares are taken from the basket, the likely tax result will be a combination of long- and short-term capital gains. International College of Financial Planning – Challenge Pathway Prep Book Page 382

 Basis also will depend on which shares are withdrawn—those purchased at $10, $8, or $5 per share.  If all the shares withdrawn are those purchased last (i.e., last in first out), the withdrawal will produce a taxable gain of $500 and will be taxed as a short-term capital gain.  If the 100 shares are withdrawn from the original investment (i.e., first in first out), there will be no gain (or loss) and no taxable amount. You can see why being able to identify purchase information can be quite important. Annuities Annuities represent a means of saving that, in most territories, allow the funds to grow without paying current taxes. The tax-deferred earnings help the annuity investment to grow larger than if taxes are withdrawn and paid annually. Many retirement programs use annuities in one form or another to fund retiree pension benefits. When the time comes to annuitize (i.e., begin receiving regular payments from the annuity) the tax situation can change, sometimes by a lot. Non-pension, non-qualified annuity payments often are taxed based on some of the money being considered a non-taxable return of premium or investment, and an amount resulting from investment earnings, which is taxable. For pension annuities (i.e., qualified retirement plans) that are not contributory, the entire distribution likely will be taxed, although some territories may exempt a portion of the payments from income. Each territory addresses taxation in its own way, and this includes ways in which annuity distributions are taxed. Non- periodic distributions—lump sums or occasional payments—often are fully taxable as investment earnings. Periodic distributions, where part of each payment is considered a return of investment and part resulting from investment earnings, often will include a formula to exclude the non-taxable portion. International College of Financial Planning – Challenge Pathway Prep Book Page 383

Of course, formulas can vary by territory and specific situation. As an example of an exclusion formula, consider the following: Each payment will be adjusted by the exclusion ratio, which is the ratio that the total investment in the annuity bears to the total expected return under the contract. o Government-provided pension annuity payments usually will be taxable as income (perhaps with some amount exempt from taxation). o Lump sum and nonperiodic payments usually will be at least partially taxable; often the entire amount will be taxed. o Periodic annuity payments from nonqualified (i.e., nongovernment pension) annuities often will be partially taxable and partially tax-exempt, based on the amount used to purchase the annuity, the payment amounts, and the payout period. o Taxation of government-backed pension (provident) funds will vary based on the territory, exemption amounts, and employee contribution amounts, and whether those amounts were ever previously taxed. Cross-Border and Source Most territories tax based on where you are living. As an example, if you live and work in Germany, you will be taxed by Germany. However, if you are a German citizen, but not living and working there, Germany will not claim any right to tax you on earnings from the non-German territory. If tax codes worked like this around the world, there would be little need to address cross-border scenarios. However, all territories do not follow this method of taxation. At the same time, most territories have entered into a system of cross-border legislation that generally keeps individuals from being taxed twice on income earned in their non-domestic territory. Cross-Border Rules and Requirements Ever-improving technology and internet-based resources, along with increased information sharing among territories, make attempting to hide income or assets difficult to the point of often being International College of Financial Planning – Challenge Pathway Prep Book Page 384

impossible. Trying to evade cross-border related tax concerns or seeking to avoid notice by tax authorities is unethical and illegal. Eventually, the authorities will uncover that which has been hidden and bring to bear the full legal force available to them. It’s far better to learn the rules and play by them. One of the rules about which people may not be aware is the common requirement to obtain a certificate of compliance with the territory’s income tax laws prior to leaving the territory. This requirement does not apply to tourists or temporary visitors, and it may not apply when a resident alien intends to return to the territory. However, because it may be a relevant requirement in cross-border scenarios, it is important to check for compliance. You may come across three main kinds of individuals with cross-border assets or income: o Foreign nationals living and working in your territory (i.e., resident aliens) o Expatriates (i.e., citizens of one territory living abroad—e.g., in your territory) o Foreign nationals living outside of your territory with assets in your territory (and perhaps in other territories) Each group has potentially different tax ramifications Those individuals who live and work in your territory may be known as foreign nationals or resident aliens. They likely were born in one territory and now live and work in your territory. While living and working in your territory, these individuals normally will be taxed in the same way as any other individual in your territory. At the same time, they may be subject to tax schemes in one or more additional territories, if they have assets or produce income in other territories. The text does not include specific guidance regarding cross-border situations. Reasons for this include the difficulty of knowing all relevant tax regulations from all territories. Further, regulations in one territory can be (and often are) quite different from regulations International College of Financial Planning – Challenge Pathway Prep Book Page 385

in other territories. Considering that some individuals may have income or assets subject to several territorial tax regimes, the implications and application of any strict set of rules becomes prohibitive. Source Rules The current residency of an individual is certainly important, but the source of any income is perhaps the most important factor. For individuals, the location in which income is generated can make a big difference in how (and where) it is taxed. If 100% of a person’s income comes from employment, business, real estate, investment portfolio, or any other assets domiciled in a territory in which they have always lived and worked, that territory’s tax scheme, including filing requirements, etc., will solely apply. This means, if I live and work where I have always lived and worked, and all my income and assets come from the same territory, I only have responsibility to file and pay taxes in that territory. The same is not true when an individual has income or assets in more than one territory. When this is the case, often, regardless of where they currently reside, the source of any income must be determined, because it can have an impact on their tax liability.  Generally, interest paid by an individual, partnership, or trust is sourced at the payor’s place of residence, and interest paid by a corporation is sourced at the place of incorporation  As a result, when a resident individual or partnership, along with trusts and corporations domiciled in your territory, pay interest, it will be considered as coming from your territory.  Dividends usually are considered to be sourced from the territory in which the corporation paying them is incorporated.  Income resulting from personal services usually is sourced from the place where the services were performed. International College of Financial Planning – Challenge Pathway Prep Book Page 386

Tax Treaties Tax treaties are enacted between two specific territories. This means that Territory A will not issue a global treaty (i.e., unilaterally with the rest of the world). It’s also worthwhile to note what usually happens when one territory does not levy a tax on income to which it might otherwise be entitled. When this happens, the other (normally, domestic) territory will assess an income tax. Avoidance of double taxation is one of the primary functions of any tax treaty. If two territories (for example) consider an individual to be a resident—especially for tax purposes—without some mitigation, the individual likely will be taxed twice on the same income. Tax treaties, or double tax avoidance agreements (DTAAs) among territories alleviate the double- taxation problem (in many situations). Sometimes a treaty eliminates the requirement to pay taxes in both territories. Tax treaties rarely, if ever, result in an arbitrage-type arrangement where an individual escapes paying income taxes to any territory. We can summarize the most common tax treaty objectives as follows  Elimination of double taxation  Certainty of tax treatment  Reduce tax rates  Lower compliance costs  Prevention of fiscal evasion  Prevention of tax discrimination  Resolution of tax disputes  Provide for tax sparing International College of Financial Planning – Challenge Pathway Prep Book Page 387

Tax Credits The other typical solution for avoiding double taxation is for the domestic territory to provide a tax credit for taxes paid in the foreign territory, to be used when the individual (or corporation, etc.) files a tax return in the domestic territory. o A tax credit is somewhat more unilateral and straightforward than a tax treaty. o Tax credits do not require bilateral agreement between two territories. Simply put, with or without a treaty, Territory A gives residents a credit for taxes paid on income earned in Territory B. o The taxes are paid in the foreign territory—perhaps at an even higher rate than would be the case domestically. o The domestic territory then provides an offsetting credit to the individual, thereby effectively allowing overall income taxation to be levied only once. o All the usual considerations come into play—residency, source of income, domicile and type of income (e.g., dividends, royalties, personal service, etc.). Income tax liability often is determined in the domestic territory currency. When money is earned in a foreign territory and income tax is paid in the domestic territory, how are exchange rate spreads addressed? In simple terms, income taxes are paid in the territory of taxation. For example:  A taxpayer in South Africa pays taxes in the local currency—Rand (ZAR).  When the taxpayer must pay taxes on income earned in another territory (e.g., India; INR), there will be an exchange rate applied of (currently) 1 ZAR = 4.53 INR.  If income was earned at this same rate, there is no gain or loss.  However, if income was earned when the exchange rate was 1 ZAR = 5.15 INR, the taxpayer would essentially pay fewer ZAR on the income earned in INR.  The reverse would also be true. If 1 ZAR = 4.30 INR, the taxpayer would effectively pay more ZAR on the income earned in INR. International College of Financial Planning – Challenge Pathway Prep Book Page 388

What happens when an individual wants to receive retirement benefits earned in one territory, but he or she now lives in a different territory? Some of the answer to this may be defined by various tax treaty agreements between territories. Unfortunately, this is not always the case, especially when retirement assets are coming from more than two territories. Normally, these accounts remain in the original territory, but benefits may be paid in the current place of residence. It’s certainly possible for account holders to liquidate some accounts (e.g., defined contribution or other non-defined benefit pension-type plans), but the income tax bill assessed on lump sum distributions is likely to be quite large. o Liquidation is not always possible, especially when working with defined benefit-type plans that only provide a retirement benefit and do not accumulate a cash fund that belongs to the employee (as in a defined contribution-type plan). o Generally, employee contributions are more transportable than those provided by the government, and in some cases, employers. Plan distributions may be taxed by the current territory of residence or the initial territory (where the account originated) o Taxes may be withheld from distributions in both territories. To recover withheld taxes, the recipient must file an income tax return in the territory that does not have the right to tax payments. o In some situations, both territories actually may have some right to a portion of the taxes, which serves to complicate the recipient’s picture. o When the individual receives a lump sum distribution, it may be taxable in either territory, and often follows different rules than periodic distribution payments. One of the key considerations that often arises is the degree to which a foreign retirement plan meets the criteria of the national (e.g., current territory of residence) plan. o This is neither always readily discernible nor easily understood. International College of Financial Planning – Challenge Pathway Prep Book Page 389

o This means a qualified retirement plan in one territory may not satisfy the definition of a qualified retirement plan in a second territory. o The implication of this being that earnings that were tax-deferred or nontaxable in the original territory may not be given the same status in the second territory. Tax Strategies  In the UK, the SA100 is the basic Her Majesty’s Revenue and Customs (HMRC) income tax form;  In the U.S., the Internal Revenue Service (IRS) uses form 1040:  South Africans may have to submit form ITR1 2 to the South African Revenue Service (SARS), while  Citizens of Saudi Arabia have no income tax, and therefore do not need to file a return. Most territories allow at least some income to remain untaxed. Most territories allow at least some income to remain untaxed. For income that is taxed, the maximum tax rates range from 0% to more than 50% at a national level. On top of national taxes, many sub- jurisdictions (e.g., states, provinces, wards, cities, etc.) collect income taxes as well. In addition to income, taxes may be levied on goods and services, real property, investment assets, and other categories. In all, and depending on the territory, taxation can become quite high. The process of limiting payment of one’s taxes often requires filing several additional forms in addition to the main tax filing form. All financial planners should research and become familiar with the realm of taxation in their own territories. However, tax planning, especially when addressing income and property (i.e., personal, real, and investment), is a key element in financial planning that we cannot ignore. Still, given the inherent difficulties, we will approach tax planning from a generalist’s perspective. Tax Systems Overview  The idea that a citizen or incorporated business should pay taxes based on nationality has its base in the perceived benefits enjoyed by citizens of that territory. International College of Financial Planning – Challenge Pathway Prep Book Page 390

 Territoriality, on the other hand, essentially focuses on the requirement that all entities earning money from a territory share in the responsibility to support that territory.  Even when a person is not a resident of a territory, that territory may assert territorial jurisdiction over income derived from the territory. Here, the focus is on the source of the income (rather than nationality or territoriality of a person).This source jurisdiction may impose a tax on royalties, investment income, rent, etc., that non-residents earn.  The normal circumstance is for all territories to cede primary taxing authority to the place of territorial connection (i.e., where the income is earned) and the residual, or secondary, taxing authority to the territory of nationality or residence.  To avoid double taxation, the territory of secondary authority usually credits any taxes paid in the primary taxing territory against any tax that might be due.  Typically, a territory only tries to collect taxes on income with which it has some connection, so, for example, the Swiss government does not try to tax income earned by a South African company in South Africa (or any other non-Swiss territory). Planned Approaches  The question for the financial planner is the degree to which the client may control the amount of tax levied and its payment. This means taking a strategic look at the client’s tax situation. Some strategies are relatively simple.  Find the proper form, complete it, and submit the form to the relevant tax authority. Many value-added tax (VAT) refunds fit into this category, as do methods used to reduce or eliminate double taxation. Double taxation occurs when two tax jurisdictions attempt to levy taxes on the same amount earned or spent. This can happen between states/provinces (or similar) and the national government. It can also happen between territories. Ways to limit double taxation vary, but almost always involve legal agreements between the taxing jurisdictions.  The taxpayer has the responsibility to identify the location where he or she earned income (for example), and any taxes paid (or required to be paid) on that income. The taxpayer also retains the primary responsibility to ensure he or she does not pay taxes more than once and to obtain refunds when appropriate. International College of Financial Planning – Challenge Pathway Prep Book Page 391

Suitability and Relevance We know that appropriate tax strategies vary territory-by-territory. Tax laws vary considerably, and financial planners have to modify their strategies to reflect relevant laws. Developing in-depth tax strategies requires specific knowledge of the territory’s tax laws and structure. Financial planners should know how to evaluate different tax-planning approaches within any territory where they have clients (and are fully authorized to practice), and understand the impact one approach may have on another. Suitability must be a consistent theme for financial planners in putting the client’s interest first. Whatever you recommend must be suitable for the client. No matter how much time is invested to develop a plan, if the recommendations are not suitable for that specific client, the plan is of little or no value. This can be especially true where taxes are concerned. The first suitability principle is that the strategy must be legal. Financial planners should never agree to a strategy that is illegal. However, not all strategies are black or white, right or wrong, legal or illegal. A strategy may fit between the two poles as a shade of grey. It may not be blatantly illegal, but it might be questionable. A professional financial planner has no business suggesting or helping to implement any financial strategies—tax or otherwise—that are not absolutely legal and ethical. This is another reason to consult with an expert, and is something the financial planner should keep in mind when evaluating different tax strategies. Offshore Investing What is offshore investing? Simply, investing offshore means the individual keeps money in a jurisdiction other than in his or her territory of residence. Some territories used for offshore investing are known to be tax havens, with a focus on safe and secure offshore investing. While it is outside the scope of this course to discuss offshore investing in-depth, we can say that it may be a sensible option for some individuals. International College of Financial Planning – Challenge Pathway Prep Book Page 392

Offshore investing offers four potential benefits: 1. Anonymity and/or privacy 2. Asset protection and limited liability 3. Lower levels of regulation 4. Tax savings However, it is not without possible problems, one of which is potential illegality. o Tax avoidance is reasonable, but evasion is not. Unfortunately, some territories view some or all offshore investing as tax evasion. Further, in the shifting legislative landscape, it’s entirely possible that what once was considered legal now may be viewed as illegal. o When this happens, the individual has an immediate concern about being on the wrong side of the law. o Moreover, he or she faces the dilemma of how best to reallocate the funds, especially if they need to be repatriated. Income Shifting Income shifting is another tax strategy that can provide tax relief, at least in some territories. In simple terms, income shifting involves transferring income from a person in a higher tax bracket to someone in a lower bracket. Most commonly, this is done by gifting money from a parent to a child (Altfest, 2007). This is not always possible, based on tax law in a given jurisdiction. Where available, income shifting can accomplish two beneficial purposes o The first removes taxable income from a parent (or other person) in a high tax bracket. This may even allow the individual to move into a slightly lower tax bracket. o The second, discussed more in the Estate Planning course, allows the individual to give substantive gifts to children or other family members. This is often beneficial in reducing the person’s taxable estate. International College of Financial Planning – Challenge Pathway Prep Book Page 393

Family Law The way in which payments to support an ex-spouse and children are treated for tax purposes varies by territory, but there are some consistencies. o Normally, child support (i.e., ongoing payment for expenses related to rearing children) is not considered to be income to the custodial (receiving) parent. Such payments almost never qualify as a tax-deductible expense to the payor either. o Often, the mother is awarded child custody, at least until the child reaches a certain age, and the father is responsible for making support payments. Support payments for children may or may not automatically end when the child reaches a certain age. o Alimony (maintenance or support) payments to the ex-spouse may or may not qualify as income and/or a deductible expense to the payor. o Similarities exist in EU territories, but even there, specific territories may have different ways of addressing this situation. Tax-Deferred Savings Some territories allow wage earners to make deposits into tax-deferred savings vehicles. Deferring taxes by making deposits into these accounts has the potential to help the deposits increase in value faster than if they were sitting in fully taxable accounts. This can be a good planning strategy. However, o A client who places all savings into tax-deferred accounts runs the risk of increased taxation upon withdrawal. o In some situations, the individual also may have to make higher withdrawals than otherwise needed to support his or her lifestyle. o This may contribute to increased retirement income taxation, and it may unnecessarily speed depletion of the retirement account. International College of Financial Planning – Challenge Pathway Prep Book Page 394

A potential solution would be to allocate some funds into tax-deferred accounts, some into tax-free accounts (if available), and others into taxable accounts. In this way, the individual retains income flexibility as well as some amount of taxation control. Tax-Free Versus Taxable Yields Some retirement plans allow individuals to invest and enjoy tax-free asset growth and earnings. Tax deferral is much more typical, but sometimes tax-free is available as well. o Investments with tax-free yields or income, but not asset capital or price growth, are somewhat more common. o This means an asset that grows in value from X to Y would be partially taxable, but any income the asset produces would not be taxable. o When an investment that produces tax-free income is available, often a similar investment exists for which yields are taxable. Know the tax-free/taxable equivalent yield calculation The tax equivalent yield is equal to the tax free interest rate divided by (1 – the individual’s tax rate). Compare tax-free vs. taxable yield The taxable yield would have to be 5.0% to be fully equivalent to the 3.5% tax-free yield. Assuming both investments are essentially equal in quality, any taxable yield above 5.0% would produce a better result for the investor in this circumstance. International College of Financial Planning – Challenge Pathway Prep Book Page 395

Use the calculation to determine yield  If the financial planner knows the taxable yield and wants to determine the equivalent tax-free yield, he or she just needs to multiply the taxable yield by (1 – the individual’s tax rate). o Taxable yield X (1 – the individual’s tax rate).  If the investor above wanted to compare a 5.5% taxable yield to a similar investment with a tax- free yield, he or she would require a tax-free yield of at least 3.85% as being equivalent to the 5.5% taxable yield. o .055 × (1-.30)= .055 × .70= .0385 Any tax-free yield greater than 3.85% would be more suitable for the individual looking for such an investment. Accounting Standards and Research How Accounting Fits Into the Tax World Accounting and taxation always seem to fit together. One reason for this is that much of what many accountants do is directly related to complying with relevant tax laws and filing requirements. Accountants are required to conform with accepted accounting standards. Each territory may incorporate some degree of modification to the accepted standards, but in general, most territories expect full compliance with relevant regulations and standards. You may wonder why international consistency in this area is so important. That’s a reasonable consideration, and we can highlight a few points to consider. Accounting principles support the economy by providing relevant, reliable financial data to global markets. This makes it easier to analyze the information and make good decisions. Clear financial rules give people greater confidence about the accuracy of financial reports. Consistent standards make it easy to compare numbers from year-to-year and organization-to- organization. All of this spurs greater accountability within governments and organizations. International College of Financial Planning – Challenge Pathway Prep Book Page 396