“It’s the HR mail again. I need to do my tax savings now and submit the proofs.” Said Monisha, a 26 years old Software professional to her colleagues Akshay and Neha.
Neha: Me too !! Where should I invest ?
Monisha: Of course PPF !! I have heard from everyone that it is the best option for 80C. Also, the markets look scary these days. I need something with guaranteed returns. Now they have increased the interest rate also on PPF. We get 8.6% guaranteed.
Akshay (smiling): Well Of course, it is “One of the best” options for 80C!! But are you aware of a few things about PPF ?
Neha (Curiously): Like ?
Akshay: First, the 8.6% is not really a guaranteed rate forever. It is actually benchmarked to the 10-year government bond yield. So for this year, the PPF will earn 8.6% which is 0.25% above the average benchmark yield in the previous financial year.
Monisha: Ohh !! So does that mean, it could earn lower returns in coming years ?
Akshay: Yes, as we know that interest rates have peaked and are expected to go down, the benchmark yield could also go down by some extent. So we might even have an year where the PPF earns 5.75%, if the benchmark yield drops to 5.5%.
Monisha: But I will toh get 8.6% only na, as I have invested in this year itself ?
Akshay: It doesn’t work like an FD Monisha. If you make an FD for 5 years at 9.5%, then it will keep earning 9.5% irrespective of the market movements for 5 years. But this won’t happen in case of a PPF. Here, the interest will be calculated every year depending on the benchmark and will be paid accordingly, irrespective of which year you invested the money.
Neha: Oh No !! PPF was the only option that was giving tax-free guaranteed returns. Now that’s also gone. I was planning to invest full Rs. 1 Lakh in PPF for tax saving purpose this year. Till Last year, I could invest only Rs. 70,000.
Akshay: Neha, we are salaried people. We anyways do not need to invest full Rs. 1 Lakh in PPF. We anyways contribute towards EPF. Suppose each month we are paying Rs. 2250 towards EPF (which gets deducted from our salary), then in the financial year, we have already saved Rs. 27,000 u/s 80C. So, now we have to save only Rs. 73,000 for tax saving purpose.
Also, while making tax saving investments, we should also consider our overall financial planning. For example, our EPF is going in debt instruments, our infra bond investments (u/s 80CCF) is going into debt instruments and now if we invest the balance Rs. 73,000 in PPF, we are holding a debt heavy portfolio. This is not good for our long term goals.
Neha: Also, one thing I didn’t like about PPF is that its maturity is too long. We would get the amount after 15 years. That’s too much of a lock-in period. Thus, PPF scores low on liquidity aspect.
Monisha: No No !! This is wrong !! PPF can be withdrawn after 5 years. I think 5 years lock-in isn’t too bad !! What do you say, Akshay ?
Akshay: I will answer this in two parts. First Part, PPF can be withdrawn after 5 years. But the withdrawn amount will be clubbed with your income for that year. So, basically whatever amount you withdraw from PPF, is taxable if you withdraw it before maturity (i.e. before 15 years of account opening).
Second part, even after 5 years of opening the PPF account, entire amount is not available for withdrawal. To give an example, suppose, Neha has opened her PPF account on 1st April 2006, and it has completed 5 years on 1st April 2011. Every year, Neha has deposited Rs. 70,000 in PPF. For calculation purposes, I am ignoring the interest part for now. So as on 1st April 2011, the balance in Neha’s PPF account is Rs. 3.5 Lakhs. However, she will be able to withdraw 50% of the balance 3 years back i.e. 50% of balance as on 1st April 2008. If the balance on 1st April 2008 was Rs. 1,40,000 then on 1st April 2011, the liquidity available to Neha is only Rs. 70,000. And that too, taxable.
Neha: See !! I was right !! PPF scores very poor on liquidity. I have Rs. 3.5 Lakhs in my account, but I can withdraw only Rs. 70,000 (only 20% of the available balance), that too taxable!!
Monisha: But you can also take a loan on your PPF. Right? Then it won’t be taxable.
Akshay: Yes, but I find it really a bad financial planning if we have to take a loan against our own investments. As regards PPF, the interest on loan will be 2% costlier than the interest which we will earn on it. So, to me, it will be a bad deal.
Neha: Yeah, me too !! I am toh planning not to invest even a single rupee in PPF this year.
Akshay: Don’t make this mistake !! Whether you like it or not, you are compelled to pay at least Rs. 500 per year to your PPF account or you need to pay a penalty.
Neha: That didn’t sound too nice, but Rs. 500 is something I can manage and pay every year. Or should I pay more?
Akshay (smiling) :As I have already told you, this decision should be driven by your overall financial planning.
Monisha (interrupting): Are you trying to say, that PPF is not a useful option any more ? I don’t agree.
Akshay : You are right !! And I was just saying the same, that this decision would vary from person to person as per his / her profile. For example, a self-employed person, of age group 30-35, who does not make any contribution towards EPF, should definitely invest Rs. 30-35 thousand per year towards PPF so that debt investment is included in his portfolio.
But salaried people like us, who are young, and should not have more than 30-35% exposure to debt, need to first work out our total EPF contribution for the year. Also, we are investing Rs. 20,000 in the infrastructure bonds (which is also a debt investment). So if the sum of both is already Rs. 37-42 thousand, then no need to invest in PPF. Just invest the mandatory Rs. 500 and forget it.
Neha (doing some calculations): So I should invest Rs. 4,500 in PPF, as Rs. 12,500 was my EPF deduction and I invested Rs. 20,000 in 80CCF bonds. So that would add up to Rs. 37,000. And what to do for the balance investments?
Akshay: Neha, Monisha, I am not an expert to be giving you any exact figures. Whatever, I have told you is what I have been discussing with my investment advisor. What is right for me, may not be exactly right for you. Monisha is 26 and already married. Neha is 24 and single. So the planning for all of us could differ. The best would be take professional help without any delay.
Neha, Monisha: Thanks for the useful info Akshay. Our doubts about PPF are also clear. And now we also understand that tax planning works best when it is in line with our financial planning too.
We look forward to your feedback and comments on the above article. (The views mentioned in the article are personal opinion of the author. The characters used in the article are hypothetical).
The Author Prof. Saurabh Bajaj (BE, MBA, FRM) is Chief Investment Planner with Nidhi Investments. He can be contacted on saurabh@nidhiinvestments.com if you have any questions.
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