Dear Comrades,
From 1 December, your investments in small savings schemes will fetch market-linked returns. The rate of interest on various small savings schemes will be pegged to government securities’ (G-sec) yield of similar maturities with a spread or mark-up of 25 basis points (bps). Even though the government has always been at liberty to change the rate of various small savings schemes from time to time, the alterations have been few and far between. But from this year, the rates will become more dynamic.
Given the development, we review five main products in the small savings schemes category to tell you if you should include them in your portfolio.
Public Provident Fund
A favourite with financial planners and advisers, Public Provident Fund (PPF) is a risk-free and tax-free product that is also capable of generating positive returns after accounting for inflation.
For about eight years, PPF has been giving a return of 8%. Assuming long-term inflation to be around 6%, the real rate of return or inflation-adjusted return from PPF is 2%. Also, PPF enjoys the exempt-exempt-exempt or EEE tax status. In other words, the contribution, accumulation and withdrawal are all tax-exempt.
Till now, you could contribute up to Rs. 70,000 in PPF, but now you would be able to invest up to Rs. 1 lakh, which will be available for deduction under section 80C of the Income-tax Act. Even under the proposed Direct Taxes Code, PPF is likely to enjoy the same tax advantage.
For this financial year, the rate of interest on PPF has gone up by 60 bps, so you will get 8.6%. Given the favourable tax treatment PPF enjoys, it continues to remain attractive as a long-term vehicle.
Says Veer Sardesai, chief executive, Sardesai Finance, a financial planning firm: “While the interest rate will change, the tax advantage far outweighs this concern. Not only is it tax-free, you also get an income deduction on the principal invested. I believe, in its present form, it continues to be our top recommendation and the raised limit of Rs. 1 lakh is also a positive.”
Will the dynamic rates affect its status? Not really. Explains Suresh Sadagopan, founder, Ladder7 Financial Advisories, a financial planning firm: “Yes, PPF rates can change going forward, based on yields of G-secs of similar tenor. But every other instrument also has the same problem. Hence, PPF may continue to remain an instrument of choice for long-term planning such as retirement and kid’s education.”
Should you maximize your your investment in PPF? The answer to this question will depend on your asset allocation. Explains Pankaj Mathpal, managing director, Optima Money Managers Pvt. Ltd, a financial planning firm: “The first step is to choose an asset allocation for your investments. After that, depending upon your asset allocation in debt you can maximize your investments in PPF as it is definitely the first pick for long-term investments.”
National Savings Certificate (NSC)
The new guidelines have shortened the tenor of NSCs from six to five years. Additionally, a new 10-year-tenor NSC has been announced, which will have a spread of 50 bps. It will be notified in a day or two. Says Kawaljit Singh, assistant director, savings bank, India Post: “We have been given to understand that the new NSC will take around two days to get notified.” For this year, the interest rate on the five-year and 10-year NSCs are 8.4% and 8.7%, respectively.
Once you buy an NSC at the prevailing rate, you get locked-in to that rate. Says Singh: “For products like National Savings Certificate, Monthly Income Scheme, Senior Citizens Savings Scheme and time deposits, which have one-time investments, the rate of return will get locked for the tenor of these products. However, for PPF, which needs regular investments, the rate of interest will vary every year.” So if you bought a 10-year NSC this year, the rate of interest of 8.7% will be applicable for the entire tenor. In isolation, 8.7% looks good, but compare it with PPF and broaden the analysis to include the tax treatment and it falls flat on its face.
The contributions you make to NSC qualify for section 80C deduction up to Rs. 1 lakh. Subsequently, even the interest that accrues every year and gets reinvested qualifies for 80C deduction. However, on maturity, the interest income is taxed at your marginal income-tax rate. Says Neeraj Chauhan, chief executive officer, Financial Mall, a financial planning firm: “Even as NSC enjoys the 80C deduction, it remains unattractive because the interest is taxable. Also, people usually exhaust their 80C limit by buying life insurance policies, investing in equity-linked saving schemes, Employees’ Provident Fund and PPF.”
So if you are in the highest tax bracket of 30.9% and have exhausted your Section 80C limit, the effective rate of return on your 10-year NSC that yields 8.7% will come down to 6.01%.
Post office time deposits
When investing in post office time deposits, you need to compare it with fixed deposits (FDs) of banks. The argument in favour of post office time deposits is that it is risk-free as it is guaranteed by the government, whereas FDs don’t have any sovereign guarantee. The Deposit Insurance and Credit Guarantee Corp. provides insurance to each customer of a bank for all deposits in the bank, including FDs, up toRs 1 lakh. However, this is available only in case of a bank failure and merger with another bank.
“But given the fact that most middle class individuals are able to take on the slightly higher risk for greater ease of operation of bank FDs, they are better vehicles,” says Sardesai.
Even in term of returns, the argument holds good. Post office time deposits and bank FDs for five years qualify for 80C deduction and the interest is taxable. Given the similar tax incentive, the only point of differentiation remains the rate of interest on the two. While post office time deposits give 8.3%, bank FDs are currently giving between 8.5% and 9.5%.
Senior Citizens Savings Scheme (SCSS)
SCSS is available for five years and can be extended by another three years. The maximum you can invest in SCSS is Rs. 15 lakh. The guidelines have suggested a positive mark-up of 100 bps for it. So if G-sec yield is 8%, the rate of interest for SCSS will be 9% per annum. This interest income is paid quarterly. For this year, the rate of interest will remain 9%.
Should you invest? SCSS also qualifies for a tax deduction under section 80C, but just like in FDs, the interest is taxable. Since both of them do not offer a tax break, the way to prioritize is in the order of decreasing returns; in the current scenario, FDs are on top.
FDs are doing pretty well. For instance, IDBI Bank Ltd is offering 10.25% on its five-year FDs to senior citizen. Says Sardesai: “In the current scenario FDs are yielding more than SCSS, hence, FDs become the first choice. Also FDs are more liquid than SCSS. One should consider SCSS only when the rate of interest is significantly higher than FDs.”
Monthly income scheme
From this year, the tenor of a monthly income scheme (MIS) is five years. The maximum you can invest in an MIS is Rs. 4.5 lakh in a single account and Rs. 9 lakh in a joint account. This year, MIS will offer a rate of 8.2%, payable monthly. Till now, MIS was also offering a bonus of 5% on maturity, but that has been shelved for this year.
Should you invest? Compare it with FDs and even SCSS and you will find that at a rate of 8.2%, it is not the best bet. Says Sadagopan: “Even earlier, MIS made sense for only those in the lower tax slabs wanting consistent monthly income. But the removal of 5% bonus will affect the yield. In its current state, MIS has become a lot less attractive.”
With the rates more dynamic, you will now need to look at comparable products, while picking small savings schemes investment products. To enable comparison look at returns and tax benefits.
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