For small savings vehicles, look at returns, tax benefits

If the news that the Employees’ Provident Fund (EPF) rate has been reduced to 8.25% from last year’s 9.50% depressed you, the increased rates for small savings schemes are likely to compensate for it. The government has increased rates for small savings instruments by 20-50 basis points for FY13.

In case of instruments such as PPF, where you need to invest every year, the rate of return would vary every year, but in instruments where you make a one-time investment such as NSC, the return will remain fixed for the entire investment tenor. However, when selecting an investment vehicle, returns should not be the only parameter; you should look at it through the prism of tax benefits, too.

Public Provident Fund

In FY12 or current fiscal, PPF earns 8.60%, a 60 bps increase from the previous year, and in FY13, which is less than a week away, it will earn 8.80%, which is 20 bps more than the current year.

In the current scenario, PPF trumps all other investment vehicles in terms of post-tax returns. PPF is a risk-free and tax-free product that is also capable of generating positive returns after accounting for inflation. In tax parlance, PPF is an EEE (exempt, exempt exempt) vehicle. Contributions in PPF qualify for a tax deduction of up to ₹ 1 lakh under section 80C, you pay no tax on interest and on maturity, the proceeds are tax-free. The tax benefit, thus, preserves the effective rate of return.

Other investments

In other small savings instruments, where you need to pay tax on maturity, the effective rate of return gets diluted.

National Savings Certificate (NSC): Here, your contributions qualify for 80C deduction up to ₹ 1 lakh. Subsequently, even the interest that accrues every year and gets reinvested qualifies for the 80C deduction. But the interest income in the last year is taxable at your marginal income-tax rate.

If you have exhausted your section 80C limit, investing in NSCs doesn’t make sense. Says Prakash Praharaj, a Mumbai-based financial planner: “About 90% of my clients exhaust their 80C limit through repayment of home loans. For individuals living in urban areas, NSC is not an instrument to claim 80C deduction.”

Agrees Suresh Sadagopan, another Mumbai-based financial planner. He says, “Individuals usually exhaust the 80C limit through PPF, insurance premiums and home loan repayment. Without 80C, income-tax will drag the returns down.” So if you are in the highest tax bracket of 30.90%, the effective rate of return on 10-year NSCs, that offer 8.90% on paper, will be 6.15%.

FDs: Even five-year post office fixed deposits (FDs) have the same problem; the contributions enjoy a tax deduction but the interest is taxable. For FY13, the five-year deposit will earn 8.50%. So if you are in the highest tax bracket of 30.90%, your effective yield is just 5.87%. In comparison, five-year bank FDs that qualify for section 80C benefits are better as they currently yield a higher return of around 9.50%.

For senior citizens

Senior Citizen’s Savings Scheme: The rate of interest for SCSS will be 9.30% for FY13. This interest is paid quarterly. SCSS also qualifies for a tax deduction under section 80C. But just like FDs, the interest is taxable. For senior citizens, too, FDs figure on the top. For example, IDBI Bank Ltd offers 10.25% on its five-year FD that qualifies for a tax deduction under section 80C.

Monthly income scheme (MIS): The rate of return on MIS will be 8.50%. This interest is paid monthly. Not only is the return low in case of MIS, it does not enjoy any tax benefit. The rate of 8.50% is not the best bet.

Unlike earlier, when rates were altered sparingly, the rate of return on your small savings investments have become a lot more dynamic. But two parameters should help you make the right decision: returns and tax benefits.

deepti.bh@livemint.com

Also See | New rates (PDF)