Strike a balance between liquidity needs and the amount that can be locked in for long term
If small savings rates decline, then target maturity roll down AAA-rated debt funds may turn more attractive
In a major relief for fixed income investors, finance minister Nirmala Sitharaman on Thursday cancelled a decision taken a day earlier to slash interest rates on small savings schemes for the June quarter by 50-110 basis points, citing oversight in issuing the order. One basis point is one-hundredth of a percentage point.
So, for this quarter, investors will continue to earn 7.1% in Public Provident Fund (PPF), 7.4% in Senior Citizen Saving Schemes (SCSS), 6.8% in National Saving Certificate (NSC) and 7.6% in Sukanya Samriddhi Yojana (SSY). Also, the Kisan Vikas Patra (KVP) will have a tenor of 124 months, as earlier, implying an interest rate of 6.9%.
Moreover, interest rates on post office term deposits, post office savings accounts and post office monthly income scheme (POMIS) will continue as earlier. The rates on post office term deposits have been retained at 5.5-6.7% for tenors of one-five years. The post office savings account rate also stays at 4%. The relief, however, may be short-lived. “I think the rates on small savings schemes will be revised lower in the coming quarter. The government is following the Shyamala Gopinath committee report, which talked about linking the interest to the sovereign bond rates," said Soumyajit Niyogi, associate director, India Ratings and Research.
This interest rate scenario has presented a key challenge to savers: should they lock in their investments, or wait for the rates to rise?
“Even if the rates would have been revised, small savings schemes will continue to outscore. Fundamentally, the schemes are a better option when it comes to return generation," said Harshad Chetanwala, a Sebi-registered investment adviser (RIA) and co-founder of MyWealthGrowth.
There are two categories of individuals who invest in small savings schemes. The first is the rich and those who use PPF, SSY and SCSS as tax optimizing instruments “Small savings schemes will be a better option for them as they don’t have any other instrument where they can get this much tax-free interest; and they are all in the 30% tax bracket," said Melvin Joseph, an RIA and founder of Finvin Financial Planners. Investments under these are eligible for tax exemption of up to a maximum limit of ₹1.5 lakh in a fiscal.
Government staff and small savers form the other category of investors. “A person should utilize the full amount in PPF as, historically, it has given more than 2% real rate of return against a bank fixed deposit, which is taxable," Joseph added.
The PPF qualifies for EEE, or exempt-exempt-exempt, status and enjoys triple tax exemptions. It means you get a tax exemption at the time of investment. Moreover, the interest earned and the amount withdrawn on maturity are tax free. However, unlike NSC, KVP and SCSS, PPF comes under a variable rate regime, which means interest payout applicable can change throughout the tenure.
instruments with lock-in periods
There are other small savings schemes where people should stay invested.
“Senior citizens should invest in SCSS till the limit. However, since that money is getting locked in, only long-term debt allocation should go there," Chetanwala added. An individual can invest up to ₹15 lakh in SCSS, and the tenure is five years, with the option to extend it for three more years.
Another safe investment avenue is NSC. There is a tax deduction benefit of up to ₹1.5 lakh per annum, and the interest is considered reinvested and qualifies for a fresh tax deduction. However, the interest in the final year, when NSC matures, becomes taxable.
Small saving schemes also have some limitations. “A big drawback is the limit on investments, unlike bank fixed deposits. Also, these come with a lock-in period," Chetanwala said, adding, “In the coming six months or so it would be better to stay in short-duration debt options which could be savings bank or FD."
If small savings rates drop, target maturity roll down AAA-rated debt funds may become attractive. “If and when savings schemes offer lower than the current rates, then Bharat Bond will be a better alternative," said Vikas Gupta, founder, Omniscience Capital, an RIA. For instance, Bharat Bond ETF as of now offers a pre-tax return of 5.68% for the 2025 ETF.
Debt funds held for longer than three years are taxed at 20% and investors also get the benefit of indexation.
When deciding on your debt allocation, strike a balance between your needs of liquidity and the amount that can be locked in for the long term.
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