The Government has recently announced new interest rates for post office savings schemes that will take effect from April 1. In most cases they have been cut by 0.1 percentage point from present levels.

So, after these tweaks, which is a better investment option — Post office schemes or bank deposits?

Post office term deposits for five years now offer 8.4 per cent against 8.5 per cent a year back. Five-year and 10-year NSC will now carry an interest rate of 8.5 per cent and 8.8 per cent respectively. PPF will now carry 8.7 per cent interest instead of 8.8 per cent this year.

So, first how do the rates compare? After 75-100 basis points cuts in their rates, five year-bank deposit rates now range between 7.25 and 9.25 per cent, against 8.5 and 8.4 per cent now offered on the five-year NSC and post office deposits. At first sight, interests on bank deposits are higher than the small saving schemes. You need to factor in the tax aspect.

Five year options

Principal invested under small savings is exempt from tax under Sec 80 C (up to Rs 1 lakh). Ditto for special tax-saving deposits from banks for five years.

But there is a tax that you pay on the interest earned. This tax liability on the interest earned, varies. Interest earned on banks deposits as well as post office deposits is taxed at your slab rate, so no issues there.

Therefore, a bank deposit that earns 9.25 per cent (the best rate) is straightaway better than the post office deposit.

But interest earned on NSC, which is accumulated, is eligible for tax benefits if there is room under section 80C. Therefore, if you are able to avail of this benefit, NSC will offer better post-tax returns than bank deposits, for five years.

This is because a bank deposit at 9.25 per cent will effectively earn you a post tax return of 6.4 per cent at the 30 per cent tax bracket. The NSC offers 200 basis points more.

Ten-year options

If you would like to park your money for 10 years, banks have hardly any instruments on offer. But the post office offers both the 10-year National Savings Certificate and Public Provident Fund (PPF).

The 10-year NSC will offer an interest rate of 8.8 per cent from April 1. The entire interest component may become taxable for an investor who has exhausted his Section 80C limits.

Interest of 8.7 per cent from PPF, in contrast, is completely tax free. However, unlike NSC, do note that the rate itself is subject to change every year. Hence, you cannot be sure of the final sum you will receive from saving in PPF. Nevertheless, the rates cannot be lower than long-term Government bond rates.

For a window of 10 years and above therefore, PPF remains the best option, no matter what your tax bracket is.

Other aspects

However, returns are not the only aspect to consider while choosing between bank deposits and post office schemes such as NSC and PPF. The former offers much easier options if you end up withdrawing your money early. Banks usually charge a penal interest for early withdrawal.

Both NSC and PPF have fairly complex rules for withdrawal, ranging from the reasons for which you can withdraw to the amount of the outstanding balance that you can encash. For instance, in case of NSC you can withdraw prematurely only in case of death, forfeiture by pledgee or through a court order. Even then the amount you can encash is calculated based on simple interest. Again in case of PPF, the investments are locked in for a period of 15 years and partial withdrawals are allowed only after the end of sixth year. The amount is subject to limits based on the outstanding amount at the end of the fourth year.

Hence if liquidity is your top priority, you may just have to trade off better returns for one.

radhika.merwin@thehindu.co.in

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