Clipped, but they still make the cut

Anand Kalyanaraman | Updated on January 17, 2018




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Deep cut

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Rates have been slashed across the board on postal small savings schemes. But many still remain attractive. Here’s a look at the schemes and how you can make the most of them

Small savings schemes, debt instruments offered by the post office, have seen big changes in 2016. In February, the government announced its intent to align the returns on these schemes more closely with market rates. This was to blunt their edge over bank deposits that were losing patronage due to lower rates.

So, interest rates on small savings schemes that were being reset annually would now be reset quarterly in sync with rates on government securities (G-Secs). In March, the plan was set into motion — much to the chagrin of small savings depositors. Rates on postal schemes were slashed across the board; the cuts, in the range of 0.4 to 1.3 percentage points (see table “Deep cut”), were to be applicable from April till June 2016. What followed was a last-minute scramble by several savers to lock into high rates by end March.

With G-Sec rates further moderating, small savings scheme rates were expected to be cut again in the mid-June reset, applicable from July to September. But the government left the rates unchanged. Don’t count on such benign neglect though. You can expect rates to change each quarter. In the near term, they may head south due to comfortable inflation levels and expected monetary easing by the RBI. However, if and when rates move up, the quarterly rate reset could work to the benefit of savers.

Different categories

Small savings schemes can be variable rate or fixed rate products. The much popular Public Provident Fund (PPF) and the girl-child oriented Sukanya Samriddhi Scheme are variable rate products in which rates keep changing throughout the tenure.

So, new rates announced for each quarter will apply to the accumulated corpus. Even though rates will now be reset quarterly, the compounding will continue to be on a yearly basis. Had the compounding also been changed to a quarterly basis, the effective return on the product would have increased. But no such luck.

In fixed rate products, the rate at the start stays till maturity. New rates announced each quarter will apply only to investments made in the quarter and will hold till their maturity. This category comprises the National Savings Certificate (NSC), Senior Citizen Savings Scheme (SCSS), Kisan Vikas Patra (KVP), Post office monthly income scheme (POMIS) and Post office time and recurring deposits. In March, investors flocked to put money primarily in the fixed rate category products such as NSC, SCSS and post office deposits to lock into higher rates for long tenures.

Small savings schemes are also categorised based on the tax break they enjoy under Section 80C of the Income Tax Act. PPF, Sukanya Samriddhi Scheme, NSC, SCSS and 5-year time deposits enjoy tax deduction while KVP, POMIS, recurring deposits and 1-3 year time deposits do not. The tax break on the investment up to a total ₹1.5 lakh a year across instruments enhances the effective return of eligible schemes.

Besides, interest on PPF and Sukanya Samriddhi Scheme is exempt from tax, and so is their maturity value, putting them in the tax exempt-exempt-exempt (EEE) category. The interest income on NSC, except in the last year, also escapes the tax net if claimed under Section 80C, making it partially EEE. Other small savings schemes suffer tax on interest. (see table, “Many a choice”).

Thanks to their tax advantages, the effective return on NSC, PPF and Sukanya Samriddhi Scheme, over a five-year horizon, can exceed 10 per cent for those in the lowest tax slab (10 per cent), going up to 16-17 per cent for those in the highest tax slab (30 per cent).

Despite the rate changes, many small savings schemes remain attractive, thanks to their returns being higher than inflation and comparable debt options — most banks currently offer 7 to 7.5 per cent pre-tax on their long-term deposits; most tax-free bonds in the secondary market offer about 7 per cent or less and are hard to get due to sparse trading. Also, with government backing, small savings schemes are as safe as they get. Here’s a look at the schemes that still make the cut and how you can make the most of them.

Sukanya Samriddhi Scheme

Fortunate parent or guardian of a girl less than 10 years of age? Your first port of call should be the Sukanya Samriddhi Scheme. You have to invest at least ₹1,000 a year and can go up to ₹1.5 lakh for each girl child (maximum two children). A pet project of the Prime Minister, the interest rate spread has been retained at 75 basis points over the comparable G-Sec rate.

The scheme still ranks top of the charts despite the rate cut in March from 9.2 per cent to 8.6 per cent — this rate is the highest rate among small savings schemes, and also beats bank fixed deposits by a mile. Besides, the EEE tax treatment is icing on the cake. With retail inflation at around 5 per cent, the product currently delivers positive real returns (rate minus inflation) comfortably.

This cumulative investment with annual compounding should help you build a tidy corpus for the education and wedding of your daughter. Deposits can now be made in the account each year for 15 years from the date of account opening; earlier, it was 14 years. Also, deposits made until the 10th of each month will now be eligible for interest for that month; earlier, the cut-off date was the 5th of each month. The account will mature on completion of 21 years from opening.

Tip: Invest early in the year and before the 10th of the month to reap more

Senior Citizen Savings Scheme

If you are 60 years or more and seek regular payouts, the Senior Citizen Savings Scheme remains a good choice. Individuals aged 55 to 60 can also open an account within a month of retirement. In spite of the rate cut in March from 9.3 per cent to 8.6 per cent, the scheme’s return is better than that of most other comparable options. The government has retained the 100 basis points interest spread on the scheme over the comparable G-Sec rate.

The maturity period is five years during which the rate at account opening applies and can be extended for another three years. You can open more than one SCSS account but the maximum investment cannot exceed ₹15 lakh.

Interest is paid out quarterly, but is taxable. Also, tax will be deducted at source if the annual interest exceeds ₹10,000. Even so, thanks to the Section 80C tax break, the effective returns can be quite high.

Tip: Submit Form 15H or 15G to avoid TDS if your tax liability is nil

Public Provident Fund

This old favourite had its rate clipped in March from 8.7 per cent to 8.1 per cent. But that hasn’t dimmed the PPF’s appeal as one of the best ways to build your retirement corpus. You have to invest at least ₹500 a year and can go up to ₹1.5 lakh. With a 15-year tenure that can be extended further with or without contribution in blocks of 5 years, this cumulative investment can be your multi-decade investment choice. There are very few such really long-term investment options — the maximum tenure of bank deposits is generally 10 years and that of tax-free bonds is 20 years. Also, the PPF still offers superior interest rates.

The 25 basis points spread of the product over the comparable G-Sec rate was retained in March. Interest on the PPF, though reset quarterly, will compound yearly. With EEE tax treatment, the effective returns can be much higher than the declared rates. Even without considering the Section 80C tax break, the PPF thanks to its tax-free interest income is delivering positive real returns currently. The balance in your PPF account cannot be attached under a court decree.

Recent rule changes let you close the PPF account after completing five financial years from the account opening for medical expenditure or higher education purpose. Premature closure comes at a cost though; the interest you will earn will be 1 percentage point lower than that you would have got otherwise. It’s not a good idea to close your PPF account or withdraw partially from it unless absolutely necessary; this will eat into your retirement nest egg.

Tip: Invest early in the year and before the 5th of the month to get the most

National Savings Certificate

The 10-year NSC was discontinued last December and the 5-year NSC saw its rate cut in March from 8.5 per cent to 8.1 per cent. Also, the compounding on this cumulative instrument was changed from half-yearly to yearly basis, reducing its effective returns. Despite this, the NSC remains a good option for those looking to lock in money at a fixed rate for five years. One, the Section 80C tax break on the initial investment can add to its returns. Besides, interest for the first four years that is reinvested is eligible for the Section 80C benefit; only the last year’s interest is taxable and there is no TDS. There is no maximum limit on the investment even though the tax break is limited up to ₹1.5 lakh a year. Each new investment in the NSC will earn the prevalent interest rate at opening until maturity.

The return on the NSC is higher than that offered by bank FDs currently, even without considering the tax break. Also, unlike the SCSS, there is no minimum age criterion to invest in the NSC, making it suitable for younger investors looking for a safe investment avenue for the medium term.

Tip: Interest income on NSC until the last year can be claimed as deduction under Section 80C

5-year time deposit

While the SCSS caters to senior citizens seeking regular income, the 5-year time deposit offered by the post office is a good choice for others who seek regular payouts. The rate on these deposits was cut from 8.5 per cent to 7.9 per cent in March. But this is still better than what most banks offer (7 to 7.5 per cent) on deposits of similar tenure.

Similar to 5-year bank deposits, the investment in the 5-year post office deposit is eligible for the Section 80C tax break. Also, interest on both these deposits is compounded on a quarterly basis and is taxable. But the post office deposit has an edge over the bank deposit, thanks to the higher interest rate and annual interest payout feature. If you have already exhausted the Section 80C limit (₹1.5 lakh) and plan to invest in the 5-year post office deposit, first scout around for tax-free bonds. That’s because without the 80C tax break, the return on the time deposit could be lower than that on tax-free bonds, especially for those in the higher tax brackets. That said, tax-free bonds on the secondary market are rather illiquid and it may be difficult to get them.

Tip: Keep track . On maturity, the deposit is automatically renewed at the prevailing rate

Also read: Those that have lost sheen

Published on July 31, 2016

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