Last week, the Union Cabinet provided relief to over five million central government employees by increasing the dearness allowance (DA) from 27 per cent to 35 per cent. It also increased the dearness relief (DR) for pensioners by 8 per cent.

These amounts will be paid to employees and pensioners with retrospective effect, from January 2010. DA is calculated as a percentage of basic salary; DR is a percentage of basic pension, based on the cost of living index.

Windfall gains are easier to dream about than manage. Here is some advice on using the money.

Clear or reduce liabilities: Start with retiring high-cost credit
card dues and personal loans. Even if you can’t clear the entire debt in one
go, start the process. Interest on credit card loans can be as high as 40-50
per cent a year and on personal loans between 12 per cent and 30 per cent.
Govind Pathak, director, Acorn Wealth, said: “A home loan is the only one
that can be continued because of the tax benefits it provides.”

Purchase medical insurance: Even if you have a company-provided plan, it makes sense to have an additional policy “Take a health plan when you are between 40 and 50 so that it runs after your retirement too,” added Pathak.

Start investing for a corpus: Use the amount to start investing
through systematic investment plans of mutual funds. Even if you make a
small start, savings over a long period can be substantial because of
compounding of investments. Equity diversified funds should be the way to
go. If it is a large sum, use the systematic transfer plan route. Anil Rego,
CEO, Right Horizons, said: “Pensioners should invest to build an emergency
kitty for medical purposes.”

Debt is a good option: Those nearing retirement should opt for debt, as
protecting the capital with stable returns is of prime importance. Use
monthly income plans that work like debt-oriented balanced funds. These
invest only 20 per cent of the money in equities.

Taxation: Homi Mistry, tax partner, Deloitte, Haskins and Sells,
said: “The employer is liable to tax the employee at source at the time of
making the payment. If arrears paid in a relevant year are not taxed in the
earlier year, the employee will be taxed in the year the payment is made.”
Therefore, the government will deduct tax at source when the amount is paid
in April.

For pensioners, the tax will depend on the total income, including the
pension amount and income from other sources. Also, the exemption limit of
Rs 2.4 lakh is available only to those above the age of 65. Not to forget
that if the tax is deducted at source, it will be on the basis of the old
tax slab.

Source : business-standard