Tax Planning: PPF, NSC or FD?

By Larissa Fernand |  19-01-21 | 
 

The mind-set of a fixed income investor is easy to decipher; preservation of capital with a guaranteed return.

In the tax saving arena, such investors gravitate towards the Public Provident Fund (PPF), the National Savings Certificate (NSC), or a 5-year bank fixed deposit (FD). All represent security of principal and an assured return.

It is natural to feel inclined towards either, with no strong preference, since the similarities abound. Here’s what differentiates one from the other. 

Risk

The NSC and PPF are sovereign backed investments, which means they are issued by the national government of a country, in this case, the government of India. This points to the highest safety since the government will not default on its obligations.

Bank deposit insurance, which was Rs 1 lakh per depositor, has been hiked to Rs 5 lakh per depositor in the Union Budget 2020. This insured amount covers principal and interest. The insurance cover offered by the Deposit Insurance and Credit Guarantee Corporation (DICGC) covers all different accounts of one depositor held with different branches of the same bank. You can read more about this on the DICGC website. 

Liquidity

Though all have fixed tenures, there is a fair amount of disparity.

Similar to the 5-year bank FD, the NSC VIII issue is for 5 years. The NSC IX issue with a lock-in period of 10 years was discontinued in 2015.

The tenure of PPF is much longer at 15 years. It is a 15-year investment with a 16-year lock-in. The first year is not taken into consideration when looking at the maturity of the account. The end of the financial year in which the deposit was made is what matters. So, if you opened the account on July 15, 2000, the 15-year tenure will commence from the end of FY2000-01 (March 31, 2001). That means it would have matured on March 31, 2016.

Once it matures, it can be extended by a block of 5 years on maturity.

Tax impact

Investments in all three offer a deduction under Section 80C of the Income Tax Act. However, PPF scores over the others because the interest earned is tax-free. The interest is added to the principal investment and compounded, and the accumulated amount is also exempt from tax on maturity.

PPF is an EEE investment; which is an acronym for Exempt, Exempt, Exempt. Here’s what qualifies it for an EEE:

  • Your investment is allowed for a deduction. So, you don’t have to pay tax on part of the income that equals the invested amount.
  • You don’t have to pay any tax on the returns earned during the accumulation phase.
  • Your income from the investment would be tax-free in your hands at the time of withdrawal.

In the case of NSC and FD, the interest is taxed. For tax purposes, income is classified under 5 heads, and interest earned falls under the last category (income from other sources):

  • Salary
  • Capital Gains
  • Profit from business/profession
  • Rent from house
  • Income from other sources 

Investment amount 

The tax benefit is subject to the limit under Section 80C, which is Rs 1,50,000, in any financial year (April 1 – March 31).

PPF is an annual investment. It is an ongoing account that has to be maintained over its entire tenure. The minimum that you can invest in any financial year is Rs 500, and the maximum is Rs 1,50,000. The investments can be made in instalments.

The NSC is a one-time investment. It can start from as low as Rs 100 and there is no maximum limit. However, once you touch the limit under Section 80C (Rs 1.50 lakh), the investments in NSC do not qualify for a tax deduction. The same holds for FD, though you will have to enquire with your bank as to the minimum amount.

Return

In all cases, the return is fixed and compounded annually.

Since the PPF is an ongoing account, the interest is adjusted every quarter (if a change is made). The rates are fixed every quarter; as of now, it is 7.1% (January 1 – March 31, 2021). It is not an ad-hoc quarterly adjustment but benchmarked against the 10-year government bond yield. This periodic exercise is to keep it aligned with the current interest rate scenario.

In the case of NSC, the interest rate is currently 6.8%. Similar to PPF, it is fixed quarterly. In the case of NSC, the rate of return is locked at the time of investment and during the tenure of the investment it remains insulated from any changes in rates. That is because once you buy a NSC, you cannot continue to add to that particular investment certificate. If you want to increase your exposure, you will have to buy another. Ditto in the case of FDs and the interest rate would vary from 6% to 7%, depending on the bank.

Investment Involves Risk of Loss.

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