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Small Saving Schemes - How to make the most of revamped small savings schemes and interest rates



Public Provident Fund

This all-time favourite option becomes even more attractive after the revamp. It has been benchmarked to the 10-year government bond yield. Your balance will earn 25 basis points higher returns than the benchmark. The biggest gainers will be investors who have already accumulated a large corpus of Rs 15-18 lakh over the past 10-12 years and could expect higher returns in the next 1-2 years before the interest rate cycle turns.

Another important change has been the raising of the PPF investment limit from Rs 70,000 a year to Rs 1 lakh. This make the PPF a good tool for retirement planning. Till now, assuming a return of 8%, a PPF investor could accumulate a maximum of Rs 20.52 lakh in his account over 15 years. Now, with an additional Rs 30,000 flowing into the account, he will be able to accumulate Rs 29.32 lakh. Plus, the Rs 2,400 interest earned on the additional investment of Rs 30,000 will escape the tax net every year.

The corpus will be bigger if we assume that the new rate of 8.6% will continue for the next 15 years. If a couple starts contributing Rs 1 lakh each to the PPF every year, they can build a tax-free corpus of Rs 61.8 lakh over 15 years. "The PPF scores over all other small savings schemes because the corpus is totally tax-free," says Lovaii Navlakhi, financial planner with the International Money Matters.

The investment is also eligible for tax deduction under Section 80C of the Income Tax Act as well as under the Direct Taxes Code. If we take into account the tax saved, the return is as high as 12.65% for taxpayers with an annual income of over Rs 8 lakh. The only negative is that loans from the PPF will now come at 2% instead of the earlier 1%.

Of course, these projections assume that the interest rate will remain at 8.6% throughout the tenure. This is very unlikely. Analysts believe that the interest rate cycle is close to peaking out and rates could move down after 2-3 quarters. We looked at four scenarios to see how the movement of interest rates will impact the PPF returns.

National Savings Certificates

There was a time when post offices were crowded with taxpayers wanting to buy NSCs before the end of the financial year. But the aura of the NSC diminished when agents found more lucrative options and investors got the same tax deduction but a higher rate from bank fixed deposits. Now, the government hopes to revive interest in this one-time bestseller by hiking the interest rate to 8.4% and improving the liquidity by reducing the tenure from 6 years to 5 years.

Should you bite the bait? We would not recommend this to investors. Five-year tax-saving bank fixed deposits still score over the NSCs (see table). Not only do they offer a higher rate of interest, but the yield is even higher because the bank deposits compound on a quarterly basis while NSCs are compounded half-yearly.

Even if the 5-year benchmark bond yield moves up to 9%, the NSC will offer an interest rate of 9.25%. Banks are already offering higher rates. Choose a public-sector bank or a private bank of repute if you are investing in bank fixed deposits. Don't be lured by lower rates offered by smaller cooperative banks. Also remember to break down your deposits into tranches of Rs 1 lakh in different banks. This is because investments of up to Rs 1 lakh per bank branch are insured against default.

Bank fixed deposits are also more liquid than an NSC. "If rates go up and you are locked in at a lower rate, you can foreclose the FD by paying a small cost. This option is not possible in case the of NSCs," says Kamal Rampuria, senior vice-president of Delhi-based AUM Capital Market. The only advantage for a taxpayer is that the interest earned every year from the NSC is also eligible for tax deduction under Section 80C.

If saving tax is not the objective of the investment, you could also consider investing in corporate fixed deposits. The interest rates are significantly higher than that offered by banks. But these high returns come with high risk. AAA-rated corporate deposits don't offer very high rates, while lower rated NCDs can offer 12-13%. Steer clear of deposits with a rating below AA.

10-year NSC

This is a new instrument introduced by the government. The 10-year NSC will have an attractive spread of 50 basis points above the 10-year bond yield. The rate for this year is 8.7%. However, since the NSC income is taxable, this option is not as good as the PPF.

Invest in it only if you have already exhausted the Rs 1 lakh annual limit in the PPF and still want the safety of a government scheme.

We looked at the post-tax returns for investments in the 10-year NSC for people in different tax slabs. The calculation has taken into account the tax savings under Section 80C at the time of investment and the tax paid on the interest that accrues every year. The post-tax returns are good in the higher income and tax brackets, but not very exciting in the 10% and zero tax brackets. Investors can also consider 10-year tax-free bonds being issued by PSUs.

The public issue of 8.19% tax-free bonds from the Power Finance Corporation concluded last week. The National Highways Authority of India is scheduled to launch one this week with a coupon rate of about 8.25%. More such public issues, including those of infrastructure bonds that can help save tax under Section 80CCF, are in the pipeline. But the interest earned from infrastructure bonds is fully taxable.

Senior Citizens Savings Scheme and post office MIS

The generous spread of 100 basis points above the 5-year bond yield given to the SCSS is a boon for retirees in times of high inflation. This year they will get 9%, but their returns could be higher if the bond yields don't decline till April. However, bank fixed deposits are a better alternative because of the higher returns they offer to investors above 60 years. Also, there is no limit on the investment (you cannot invest more than Rs 15 lakh in the SCSS) or the straitjacket of a compulsory quarterly payout.

However, the cost exiting the SCSS is lower than the penalty levied by banks for foreclosing a fixed deposit. If you withdraw from the scheme after one year, the penalty is 1.5%. After two years, this gets reduced to 1%. In case of fixed deposits, it can be up to 2% of the amount. The SCSS is also attractive from a taxpayer's standpoint. Investments are eligible for Section 80C benefits, though this could change under DTC.

If tax saving is not a concern, perhaps short-term debt funds would be a better alternative. These funds invest in debt instruments and are far more liquid than fixed income options. "With interest rate peaking out at this point in time, it is better to go for open-ended short-term debt funds," says Chaitanya Pande, head, fixed income, ICICI Prudential Mutual Fund. Another favourite option of retirees has been marginalised in the revamp. The post office monthly income scheme will earn a marginally higher rate of 8.2% but the 5% bonus on maturity has been scrapped.

Time deposits and savings account

Your post office savings account would also fetch you a slightly higher interest rate-from 3.5% earlier to 4% now. The RBI's decision to deregulate the interest rates on savings bank accounts has already triggered a rate war among banks. Some private banks like Kotak Bank, IndusInd and YES Bank are offering higher rates of 5.5% on savings bank deposits of up to Rs 1 lakh and a higher rate of 6% for balances beyond that.

The only thing going for the post office savings bank is that the interest of up to Rs 3,500 a year is tax-free. In case of joint accounts, this tax-free limit is Rs 7,000. Besides, the post office is very lenient when it comes to the minimum balance in your account.

Instead of the Rs 5,000-10,000 required by private banks and Rs 2,000-3,000 required by PSU banks, the post office has a low limit of only Rs 500. But the shortcomings far outweigh these benefits. One has to personally visit the post office for operating the account because it does not have ATMs or Net banking facility.

The interest rates on term deposits of different maturities have also been hiked. One-year and two-year deposits have seen the steepest rise (130-150 basis points) in rates. But these still remain unattractive compared to the deposit rates offered by commercial banks. The revamping of the small savings schemes and the introduction of the market-linked returns is a major shift in the way government schemes work.

Clearly, investors need to reassess the small savings options afresh before they commit money. "Understand the changes in the scheme properly and invest with a lot of caution. Don't invest blindly in any scheme," advises Kartik Jhaveri, director of Mumbai-based financial planning firm Transcend Consulting.

Source : ET Bureau back

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