Save Smart. Small savings, big blow

If you are one of those who swear by the old faithfuls from the post office such as National Savings Scheme (NSC) or the Public Provident Fund (PPF) for your regular investments, it may be time to re-work your returns.

After holding the rates on small savings schemes for two consecutive years, the Centre has reduced rates by 60-130 basis points, effective April 2016.

The post office term deposits for five years will offer 7.9 per cent against 8.5 per cent last year. Five-year NSC will carry an interest rate of 8.1 per cent, lower than the 8.5 per cent on offer a year back. The government has also cut rates on the good old PPF by 60 basis points to 8.1 per cent.

So, after the huge cut in rates, which is a better option — post office schemes or bank deposits?

Rates on bank fixed deposits have been trending lower by 100 to 125 basis points across different tenures in the last one year or so.

At first glance, rates on bank deposits and small savings schemes may seem comparable, but there is the tax aspect to consider.

Let us look at choices in the fixed income category apart from employee provident fund (for the salaried). Post office term deposit, NSC, PPF and bank fixed deposits (tax-saving) are all investment options under which the principal invested is exempt under Section 80C, up to ₹1.5 lakh. But tax liability on the interest differs.

Interest on bank deposits as well as post office deposits is taxed at your slab rate. Hence, a bank deposit that earns you 9 per cent (best rate) clearly trounces the post office deposit. But currently, only Deutsche Bank offers 9 per cent on its five-year tax saving deposit.

DCB Bank offers a lower 8 per cent. Five-year bank deposit rates of other banks average between 7.5 and 7.8 per cent.

Barring the best rates offered by two banks, you may be better off with your five-year post office term deposit that now offers 7.9 per cent.

But in the case of NSC, interest earned is accumulated until the fifth year and is eligible for tax exemption, if there is room under Section 80 C. Only the fifth year interest is taxable.

Thus NSC, even after the sharp cut in rates, offers better post-tax returns than bank deposits for individuals in the higher tax brackets.

For the 10, 20 and 30 per cent tax brackets, the five-year NSC offers post-tax returns of 10.3, 12.8 and 15.8 per cent respectively. Post-tax yield that a tax saving bank deposit (at 9 per cent) offers is 10.5, 12.4 and 14.7 per cent.

For a lower, say 8 per cent on bank deposits, NSC is the best option across all tax brackets. If you want to park your money for 10 years, banks have hardly any instruments on offer.

But the post office offers PPF. The 10-year NSC was discontinued last December.

Interest of 8.1 per cent from PPF is completely tax-free.

The post-tax yield works out to 10.5, 13.2 and 16.4 per cent for the 10, 20 and 30 per cent tax brackets respectively. Despite the sharp cut in rates this year, PPF remains the best option for the long haul.

So your small savings schemes still seem to fare better than bank deposits. But that’s for now. Unlike in the past, when these rates were reset every year, the Centre will now revise them every quarter based on the prevailing rates on government bonds.

These rates will apply from April 1, 2016 till June 30, after which rates will be tweaked once again.

Given that rates on government bonds are trending lower, particularly in the past month, rates on small savings schemes are likely to go down by another 10-20 basis points.

Even if a few banks are able to hold rates on their deposits, small savings scheme for the shorter tenure may lose their sheen. Also, since rates will now be subject to change every quarter, you cannot be sure of the final sum you will receive in the case of PPF.

The interest on balance in your PPF account is compounded annually and is credited at the end of the year.

The interest calculation is done every month: it is calculated on the lowest balance in the account between the 5th and last day of the month.

Since rates on government bonds are now moving down, you may also have to set aside the entire sum you want to invest in small savings schemes at the beginning of the year itself, if you are looking at earning higher returns.