Big Story | The three best small savings schemes

National Savings Certificate: Zero-risk with good effective returns

The five-year National Savings Certificate (NSC) scheme available at post offices can be considered by those seeking a no-risk, medium-term investment with relatively good returns.

The rate on the NSC was cut sharply from 7.9 per cent per annum (pa) in the January-March 2020 quarter to 6.8 per cent pa in April-June 2020; the rate has not been changed in the July-September 2020 quarter.

Despite the fall in rate, the NSC is a good bet for those in the old tax regime (that allows tax breaks) who have not exhausted their investment limit under Section 80C (up to ₹1.5 lakh a year).

For such individuals (in the 20 per cent and 30 per cent tax slabs), the NSC is a good choice for many reasons.

One, the rate on the five-year NSC is higher than what most bank fixed deposits currently offer (5.5-6.5 per cent). Each investment in the NSC will earn the interest rate at the time of opening (6.8 per cent during July-September 2020) until maturity; so, one can lock into the rates and need not worry about quarterly rate changes affecting the value of the investment.

Two, the NSC comes with zero risks — being fully guaranteed by the government. No fixed-income options by banks or companies can boast this level of safety.

Three, the investment is open to all — there are no restrictions, unlike the Senior Citizen Savings Scheme (SCSS) or the Sukanya Samriddhi Scheme .

Naveen Wadhwa, Deputy General Manager, Taxmann.com, says that unlike the previous rules that prohibited non-residents from making any investments in the scheme, the new scheme details announced in December 2019 do not contain any such provision, and so it appears that non-resident Indians can invest in the NSC.

Four, you can invest any amount in the NSC — the minimum is ₹1,000, you can invest in multiples of ₹100, and there are no caps such as ₹1.5 lakh a year in the case of public provident fund (PPF) or ₹15 lakh in SCSS.

But the deduction under Section 80C is restricted to ₹1.5 lakh a year across investments, including NSC.

Five, the money is invested for a reasonable time period — five years — and is not locked in for too long. Six, the NSC is a cumulative instrument that compounds interest annually — this can help build a good corpus at the end of the five-year period.

Finally, the NSC can deliver healthy effective returns, thanks to the Section 80C tax break that is available on the investment and also on the interest for the first four years that is reinvested.

Considering the tax breaks, the post-tax effective annual return on the NSC can be in the early to mid-teens for those in the 20-30 per cent tax slabs. There is no tax deducted at source on the interest received in the fifth year, but you must pay tax on it on your own.

The NSC can be purchased in a single name, joint names (maximum three adults), a minor above 10 years of age, or an adult on behalf of a minor. The NSC will be issued in the shape of a passbook. An investor can hold any number of NSC accounts.

Premature closure

Premature closure of the NSC is allowed in case of death of the account holder or when ordered by a court.

Depending on the period for which the investment has been held before the premature closure, there will be penalty applied, and interest amount would be reduced.

For instance, if the premature closure is before a year from the date of deposit, only the principal amount shall be repaid. If closed after three years, the interest will be paid at the rate applicable for post office savings scheme account (4 per cent per annum currently).

Not for everyone

While the NSC is a good scheme, it may not be suitable for everyone. For those seeking periodic payouts, the NSC is not suitable as it is a cumulative instrument.

Then, for those in the 5 per cent tax bracket, the effective return on the NSC is the same as the interest rate — the Section 80C tax break doesn’t add to returns since the full rebate benefit means they anyway don’t have to pay tax.

Next, if you are in the old tax regime but have exhausted your Section 80C limit without the NSC investment, the effective tax rate will not be enhanced by investing in the NSC. Tax will apply on the interest earned (currently 6.8 per cent), and the post-tax return will be 4.7-5.4 per cent (for those in the 20 per cent to 30 per cent tax slabs).

Also, for those choosing the new tax regime, with no tax break under Section 80C, the NSC’s returns fall.

The pre-tax return (6.8 per cent currently) will be taxable and so the post-tax returns come down to 6-4.7 per cent for those in the higher tax slabs (10-30 per cent). In such cases, you may be better off with other higher-yielding options such as deposits of small finance banks and a few private sector banks that offer higher rates.

Public Provident Fund: Tax-efficient investment for long-term goals

Are you looking for a low-risk fixed-income investment option to meet your long-term goals such as retirement, or child’s education and wedding?

You can consider the Public Provident Fund (PPF) — a government-supported savings scheme — given its decent returns and long tenure of 15 years.

The interest payable on PPF is revised quarterly by the Centre.

For the current quarter ending September 2020, the PPF offers an interest of 7.1 per cent. Most bank fixed deposits with a maximum tenure of 10 years currently offer interest rates that are 150-180 basis points lower than than of the PPF.

While a few small finance banks offer higher interest rates on their long-term fixed deposits, the post-tax return of PPF looks better under both the old and the new tax regime.

While the comparative investment scheme, the Employees’ Provident Fund (EPF), too, generally offers higher returns (for FY20, EPF declared 8.5 per cent interest as against an average of 7.95 per cent on PPF) with similar tax treatment, it is accessible only to the salaried.

Also, the EPF corpus is locked till the age of 58 years, making it less liquid.

PPF is open to everyone and its tenure of 15 years (with a facility to extend) allows you to save towards medium- to long-term goals.

An Indian resident can open a PPF account in a post office or through any of the public sector banks or select private banks such as Axis Bank and ICICI Bank.

If an individual becomes a non-resident after opening a PPF account, they need not close the account but should file a declaration regarding the change in residency, says Alok Agrawal, Partner, Deloitte India.

Investment limits

The minimum and the maximum limits of investment in a PPF account per financial year are ₹500 and ₹1.5 lakh, respectively. There is no limit on the number of times deposits can be made into the account in a particular financial year, subject to the overall investment limit.

Interest accrues

The interest on PPF at applicable rates for each quarter gets credited to the account at the end of each financial year and compounds annually.

Note that the subscriber will be better off making the deposits before the fifth of a given month because the interest on PPF is calculated on the lowest balance in the account from the close of the fifth day to the end of the month. Thus, if deposits are made after the fifth of a month, the subscriber will lose interest for that particular month.

Tax-efficient

PPF is a tax-efficient fixed-income option under both the old and the new tax regime.

Under the old tax regime, investment in PPF is eligible for tax deduction under Section 80C of the Income Tax Act, while interest earned and the maturity amount are also tax-exempt.

Under the new tax regime, there is no tax break on contribution made to a PPF account. However, the interest accrued and the maturity amount received from the PPF account continue to be tax-exempt.

Obtain loan against deposits

A subscriber to PPF can obtain a loan against the PPF account from the third financial year but before the sixth financial year of opening an account. The loan is capped at 25 per cent of the balance at the end of the second year preceding the financial year in which you apply for the loan.

The account holder should repay the principal amount of the loan within 36 months.

After the principal amount is fully repaid, an interest of one per cent per annum has to be repaid in the next two months.

“The balance in PPF equivalent to the loan amount will not earn any interest until the loan is completely repaid,” said Sunil Gidwani, Partner, Nangia Andersen Consulting.

If the loan is not repaid wholly within 36 months, the rate of interest on loan shoots to 6 per cent per annum from one per cent.

Withdrawal, pre-mature closure

After the expiry of the sixth financial year (when the loan facility is not available), the subscriber can either withdraw (not more than 50 per cent of the balance as at the end of the fourth year preceding the financial year of withdrawal or at the end of the preceding financial year, whichever is lower) or apply for premature closure of the account.

Premature closure is allowed on any of the following grounds: treatment of life-threatening disease, higher education, or on change in residency status of the account holder. In case of pre-mature withdrawal, interest at one per cent lower than what is applicable would be paid on the account.

The account will also be closed in the event of the death of the account holder.

Extension

On maturity, the PPF account can be continued to be extended for blocks of five years.

Post-maturity, the account holder may also decide to retain the account (without any new deposits), which will continue to earn interest.

Senior Citizen Savings Scheme: Safe haven for your retirement corpus

With limited avenues of income and a low risk appetite, investment choices can get trickier for seniors. Most banks are mindful of senior citizens’ needs and offer them deposits at slightly higher rates.

Currently, public sector banks offer seniors interest of 4.9- 6.3 per cent per annum on deposits of up to five years. Private banks offer up to 8 per cent on deposits of up to three years and up to 7.65 per cent for longer maturities.

A few banks, such as SBI, ICICI Bank and HDFC Bank are offering seniors an additional rate of 75-80 basis points (bps) over the prevailing rates, for deposits with maturity of over five years.

But the rates offered by these banks is still only 6.2- 6.55 per cent.

The post office Senior Citizen Savings Scheme (SCSS) manages to better the banks by offering 7.4 per cent per annum. The rate of interest remains constant until maturity.

The scheme comes with a standard five-year maturity, which can be extended for another three years.

However, if you are looking to earn compounded returns, SCSS is not a choice for you, since it offers only quarterly payouts.

The SCSS comes with an implicit government backing, which makes it score high on the safety quotient.

The safety net on your bank deposits, on the other hand, is limited to an insurance cover of ₹5 lakh (on all deposits in one bank).

Eligibility conditions

The SCSS also has entry restrictions. Only senior citizens (aged 60 years or more) can open an SCSS account.

While multiple accounts can be opened under the scheme, an investor cannot deposit more than ₹15 lakh collectively under all the accounts.

Cumulatively, a couple can invest up to ₹30 lakh in SCSS, if both satisfy the age condition.

Early retirees — aged 55 years or above — who have opted for VRS (voluntary retirement scheme) or retirement on superannuation, can also open an SCSS account. This is, however, subject to the account being opened within one month of receipt of retirement benefits. Also, in such as a case, the maximum amount that can be invested in the scheme is capped at the amount of retirement benefits, or ₹15 lakh, whichever is lower.

Investors can also open an SCSS account through the branches of certain banks such as ICICI Bank and SBI.

Taxation aspects

Investments in SCSS are eligible for deduction under Section 80C of the Income Tax Act.

Akin to interest earned on bank deposits, senior citizens can avail themselves of a deduction of up to ₹50,000 in a financial year for interest earned on post office schemes as well (under Section 80TTB). Tax shall be deducted at source at the rate of 10 per cent on the interest earned on SCSS, if it exceeds ₹50,000 in any financial year.

To avoid the hurdles of applying for a tax refund, seniors can submit a declaration in form 15H to their banks, if their income does not exceed the taxable limit.

However, you cannot claim both these deductions (80C and 80 TTB) if you opt for the new (lower) tax rates.

Extended maturity

The SCSS can be further extended for a period of three years, within a year of maturity. In such cases, the interest for the extended period will be the rate applicable to the scheme on the date of maturity.

Premature withdrawals

From December 2019 onwards, seniors can make premature withdrawal (only once for an account) at any time before maturity (using Form-2). If the withdrawal is made within a year of opening the account, no interest shall be paid; even the interest that has been already paidshall be recovered.

If withdrawal is made after a year/two years, 1.5 per cent/1 per cent of the deposit shall be deducted.

Investors should also note that the premature withdrawal shall be subject to tax if a deduction under Section 80C is claimed at the time of investment in SCSS. If the premature withdrawal is made due to the death of the depositor, the principal amount withdrawn by the nominee/legal heir is exempt from taxes. However, the interest earned on the deposit will be taxable in either case.

Claims by legal heir

On the death of the account holder, the legal heir or nominee is required to make an application in Form-3 (account closure form).

If there is any delay in making such a claim, the survivor/nominee should also note that interest at the prevailing rates for post office savings account (currently, 4 per cent per annum) shall be paid on the deposit from the date of death of the account holder till such claim is made in Form-3.

In cases where the spouse is the sole nominee, or when a joint account is opened (permitted only with spouse), the spouse can continue the SCSS account with the same term and conditions as the deceased account holder.

This is, however, only permitted if the spouse meets the eligibility conditions for SCSS as on the date of death of the account holder.