Paint the town red with post office savings

If you love the boring predictability of debt investments, you must have been spoilt for choice by now. Every week, there’s been a new bond offer from a behemoth institution soliciting your money with tax-free interest as high as 8.8-9 per cent; that too for the next 10-20 years. For once, banks are scrambling for your deposits with 9 per cent plus rates.

And the RBI did its bit to woo you by offering inflation-indexed certificates at a mouth-watering interest rate of over 11 per cent. All this is forcing lesser borrowers, like lower-rated NBFCs, to ratchet up their interest rates to a sky-high 12-13 per cent on their own NCDs (Non-convertible Debentures).

But don’t allow all this hoopla around deposits and bonds to distract you from regular investments in the humble post office.

Here’s why some post office schemes still score over the Johnny-come-latelies in the bond market.

PPF interest rates are liable to change each year and the interest rate for 2014-15 has just been pegged at 8.7 per cent.

Despite the small change in rates in the last few years, PPF continues to trounce other long-term bond options on quite a few fronts.

One, unlike tax-free bonds where only your interest escapes tax, your principal invested in the PPF enjoys a tax break, too.

Remember the tax deduction under 80C for investments up to ₹1 lakh? So say you put in ₹1 lakh in PPF and you are in the 10 per cent tax bracket.

Considering the tax break, it is as though you were investing only ₹90,000, but earning interest for a ₹1-lakh investment.

This boosts your returns on PPF. In tax-free bonds, you don’t get this tax break. Two, keep in mind that the tax-free bonds could offer up to 9 per cent interest in 2013-14 only because Government bond yields touched multi-year highs this year.

These rates tend to be as whimsical as India’s monsoon, so don’t count on their being equally attractive next year.

Three, PPF compounds your returns, too, thus multiplying your returns. Tax-free bonds, in contrast, pay out your interest; you need to systematically track and reinvest the money to get the maximum benefit. PPF, being a sovereign instrument, is also safer than tax-free bonds, which are raised by companies and rated by credit rating agencies according to their risk profile.

PPF also scores over the RBI’s inflation indexed bonds. With PPF interest being tax-free, it offers better post-tax returns. Interest on inflation indexed bonds is taxable at your slab rates of 10, 20 and 30 per cent.

In all, PPF is the only long-term instrument offering tax breaks on the initial investment as well as on the interest and maturity proceeds, both in the present scenario and in the new Direct Taxes Code, if it is implemented by the new Government.

Hence, even as the rate remains unchanged at 8.7 per cent for this year, it should be your top investment pick on the fixed income side.

Our tip : The beginning of a new financial year is the best time to invest in the PPF account as it can earn interest for the whole year.

If you plan to invest in instalments, ensure that you invest before the fifth of any month as the interest is calculated on the lowest balance in the account between the fifth and the last day of each month.

A few hundred rupees of additional interest earned each year can translate into a considerable sum on maturity.

After recent tweaks to their interest rates, five-year post office time deposits and the five-year National Savings Certificates (NSC) now offer similar interest rates of 8.5 per cent. Between the two, the NSC remains the slightly better investment. Although both investments are eligible for Sec 80C deduction, interest on five-year time deposits is taxable.

In the NSC, each year’s interest is considered a reinvestment until the fifth year. So, only the fifth year’s interest is subject to tax.

This pushes up the post-tax yields on the NSC. For the 10, 20 and 30 per cent tax brackets, the five-year post office deposit will fetch a post-tax yield of 10.4, 12.3 and 14.5 per cent, respectively. Comparative post-tax yields on the five-year NSC are at a higher 10.9, 13.4 and 16.4 per cent, respectively. But do remember that interest on NSC should be shown under the head ‘Income from other sources’ in your tax return, and then the 80C deduction claimed for reinvestment of interest.

Do five-year tax saver deposits of banks stand a chance against these? For example, Lakshmi Vilas Bank offers one of the highest rates of 9.5 per cent on tax-saver deposits. This is a good 100 basis points higher than the NSC.

But the tax levied on interest decimates your returns from bank deposits. The TDS on interest each year also ensures that the entire interest earned in a year is not compounded. Hence, if you are looking for a really safe option with a five-year holding period, go for the five-year NSC. Alternately, you can also divide your allocation between the PPF and the NSC in alignment with your needs.

Our tip : Waiting it out till March 2015 to see if banks hike rates on tax-saver deposits may not bear much fruit.

Interest rates and thus bank deposit rates are more likely to be on a downward trajectory then, than the other way round.

Summing up, while the market may be awash with tax-free bonds, NCDs and RBI bonds right now, remember that these opportunities are all one-off. The decision on whether to open up these options for 2014-15 will lie with the new Government.

And whether the bond offerings of the next fiscal will be as lucrative as this year’s crop will depend on many factors — the sums that the Government allows them to raise, the direction of interest rates and the identity of issuers, among others.

With the post office schemes, there are no such uncertainties. All the more reason why they deserve a reserved share of your fixed income kitty.

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