For years, traditional Indian investment mentality has largely been to remain risk- free. People simply didn’t want to put their hard earned money into something risky like Stocks or Mutual Funds. Where as Fixed Deposit(FD) in banks has been a primary investment avenue, even if inflation and taxes eat into most it’s returns. A part reason for this mentality is their understanding that the money in a bank FD is secure investment. And its mostly true, considering most of India’s banks are owned by the government. So it’s but natural for the people to deduce that ultimately the government is baking their money. The other part of the reason is the simplistic nature of FD. Go to a bank, instruct the official to put certain amount at a predefined rate of interest for a specific term. It’s fairly straightforward. One doesn’t need to watch it over after or do any kind of mid-term review once the investment has been made. Yet another part of the reason, I would say, is the general lack of education and awareness regarding how different kind of investments work, where actually the money gets invested, what are the factors (internal or external) that affect returns. All these require a certain amount of reading, research, self-education and even professional help. And naturally, people would be somewhat afraid to invest into something they don’t understand.
The thing is that the people who are really into Bank FDs for their long term investment needs and also the people wanting to counter balance their equity portfolio with even safer alternatives to debt funds, should consider schemes brought up by the government itself. Some of them are Senior Citizen Savings Sheme, Post Office Savings Account, Post Office MIS, Sukanya Samridhdhi Account, NSC, KVP etc… These schemes are collectively known as Small Savings Schemes (SSS). They are operated by government/government departments and offer variety of terms, interest rates, taxation benefits etc…
One such scheme is PPF or Public Provident Fund. It was introduced way back in 1968. Though millions of people have enrolled in it so far, the outreach of the scheme seems not on par with what it should be for a good scheme like this. Reason for this may be some of the misconceptions about it. Recently, I came across a person who thought that PPF was only for government employees. People also think of it as a blocked investment(true partially). But let’s, instead of loading and shooting one bullet at a time, just load them all at once.
Scheme Details – PPF
The aim of the scheme can be anything like building a debt portion of your investment portfolio, building a retirement corpus or whatever specific goal you can come up with for this kind of an investment.
Any resident Indian having a PAN number can open a PPF account. Even government employees, who already have GPF or EPF(commonly known as PF), can open this account. It can also be opened in the name of a minor child. A person can open only one PPF account in his name. Joint accounts are not allowed. An NRI can not open this account unless he/she had opened a PPF account before gaining an NRI status. Such accounts can be continued till maturity and not any further.
- How it works
A PPF account can be opened at designated branches of banks and post offices. Once opened, you need to keep it active by depositing at least Rs. 500 with atleast one transaction per year. Maximum of 12 such deposits are allowed during a year. Deposits need not be once a month (as one may assume from the figure 12), and can be as per one’s convenience. Account becomes inactive if minimum deposit requirement for the year is not met. An inactive account will not earn any interest. Also, withdrawals and loans are not allowed in an inactive account.
Like I said, the minimum amount that can be deposited in a PPF account in a year is Rs. 500/-. Maximum amount is currently capped at Rs.150000/- (Remember, this limit is not set by IT Act for taxation, we will see that down below. This limit is a maximum permissible amount that would earn interest as per PPF Act). Depositing more than the permissible limit will not only go against PPF Act rules, the excess amount would not earn any interest too. Although it is an individual account limit, in a way, it is a combined limit for a person’s own account as well as accounts of minors in which he is a guardian. Say for example, a person has opened total of 3 PPF accounts. One in his own name and the other two in the name of his kids. Then he is allowed to deposit a total of Rs. 150000 in all of the three accounts combined and not Rs. 450000 (Rs. 150000 per account). (Think of it as a PAN number based investing. 150000 per PAN number. Until minor kids become major, guardian’s PAN number is used for investment purposes. Therefore the combined limit.)
For the tax purposes, this scheme is EEE. That is,
Deposit of up to Rs. 150000 is exempt from the taxable income. (Now, this limit is set by IT Act. Currently, it coincides with the limit set by PPF Act for deposits. People often confuse this two limits as one thing, but they are different. To understand this, suppose that PPF rule changes the maximum deposit limit to Rs. 250000 in a year. Now, until and unless, IT department changes its exemption limit (currently Rs.150000), you will only get Rs. 150000 exempted from your taxable income.
Interest earned in PPF account is completely tax free.
Upon maturity, total withdrawable amount is tax free.
Also, PPF amount is free from court attachments and wealth tax.
- Interest rate, Maturity and Withdrawals
From 2016, government has decided to recalibrate SSS’s interest rates on quarterly basis. For PPF, current interest rate is 7.8% per annum (for October-December-2017 Quarter). Interest is calculated on monthly basis but is compounded yearly. (Remember, tax and interest related calculations in this scheme are based on financial year(FY), so when I quote some year, say ‘2017’ to explain something, just assume that I am talking about 1-4-2017 to 31-03-2018.)
Initial maturity period for this scheme is 15 years. At maturity, an account holder can withdraw full amount or he has the option to further extend the account by a block of 5 years (with or without deposits). Any number of such blocks can be taken as per will of the account holder. The amount in a PPF account will continue to earn interest in extended period.
Partial withdrawals are allowed from the sixth FY onwards from the year of opening the account. It can be upto 50% of the account balance at the end of the fourth FY immediately preceding the year in which such withdrawal is made or 50% of the account balance at the end of last FY, whichever is lower and so on. (Suppose a person has opened a PPF account in 2012, then in 2018, he can withdraw 50% of the account balace as on either 31-03-2015 or 31-03-2018, whichever is lower.) Only one withdrawal is allowed in a year. In an extended period without deposits, withdrawal is allowed once per year from the first year onwards, and there is no limit on withdrawal amount. If an extension period is with deposits, though one withdrawal is allowed per year, total withdrawable limit is 60% of the account balance at the start of an extension period.
Untill 2016, full premature withdrawal was allowed only in the event of the death of the account holder. In 2016, a government notification made the premature closure of a PPF account possible in certain cases as below —
— The money is required for a treatment of a life threatening disease of a family member (account holder, spouse, dependent children, dependent parents). Necessary papers proving the condition are required.
— The money is required for the purpose of higher education of an account holder. Here, too, necessary papers confirming admission into a recognised institution are required.
Premature closure is allowed on above mentioned grounds only if the account has completed five FYs. Also, a 1% interest penalty will be levied on premature closure of a PPF account.
Loans are available in 3rd year to 6th year from the opening of the account. Loan tenure is 36 months and interest rate on loan is 2% more than the interest rate you earn in your PPF account. Loan amount is limited to 25% of the account balance at the end of 2nd FY immediately preceding the FY in which the loan is applied for. At the time of withdrawal, any unpaid loan amount is recovered. Loan amount attracts PPF interest rate plus 6% in case you dont repay within 36 months.
Well, that is pretty much it about this scheme. Apart from loans and withdrawals, it makes a really good debt portion of your wealth building portfolio. If you don’t opt for partial withdrawals, you would see a real benefit of compounding over the years. Also you don’t have to worry about the tax liability on maturity. It may not be as flexible as bank FDs but as a long term investment, on the part of returns and taxation, it wins hands-down.
Will be back soon…