This is the second article in a five-part series on tax planning. Also read: Be holistic in your tax planning.
Every portfolio needs a balance between various asset classes and types of instruments. While we have often written on the importance of equity in a portfolio to beat inflation and create wealth, we have never stated that it must be the only asset class in your portfolio.
The Public Provident Fund, or PPF, is the perfect example of an investment every individual must consider.
Under the safety umbrella, no other instrument can match this one.
For one, the investment is perfectly and absolutely safe since it is backed by the central government. In other words, it offers the highest level of security one can get on any investment.
Not only is the capital protected, but even the return is guaranteed, though flexible. The annual returns were initially fixed at 12% and in 2000 got lowered to 11%. Since then it dropped gradually to 8% and over the past few years has fluctuated between 8.60-8.80% because they are reset every financial year. Going ahead, it will be done quarterly.
So while the return fluctuates, it is still assured.
Not only does such an investment offer stability to a portfolio, but it even offers a tax break.
Investments in PPF are entitled to a tax exemption up to Rs 1,50,000. What’s more, even 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.
You cannot get any other fixed return investment with such a benefit – tax-free interest combined with a tax break.
Here’s how to get the best out of it.
The range of investment is fairly wide. The minimum investment is Rs 500/annum and it can go up to a maximum Rs 1.50 lakh, which is the limit under Section 80C. The amount does not have to be invested at one go but can be done over maximum 12 installments in a year. If you struggle with cash flows, this aspect takes care of it.
However, if you do have the money to spare, it would make sense to invest it at one go at the start of the financial year. That’s because while the interest is only added to the account at the end of the financial year, it is calculated on a monthly basis. So if you deposit the entire amount that you wish to invest before April 5, you get the maximum gain.
The interest is calculated on the lowest balance between the fifth and the last day of the month. So to maximise your earnings, if you make multiple deposits, ensure that you do them between the 1st and 5th of the month.
What generally tends to put investors off is the long tenure of the PPF account. The PPF account has to be held for 15 years, and then can be extended in blocks of 5 years. However, the 15 years are calculated from the end of the year in which the initial subscription was made. In reality that translates to 16 years.
However, this can work to the investor’s benefit as a smart savings tool. The money is locked in – which makes it an excellent long-term savings tool, you get a tax break, the interest-free return is compounded annually and not taxed. This is a great way to accumulate money for a goal. For instance, if you are 30 years old when you open an account, on maturity the money could come in handy for your child’s higher education. If you are viewing it as a retirement kitty, then on maturity, extend it by a 5-year block. Or, if you are your spouse are each managing your own PPF accounts, one account can be used for retirement savings, the other for another goal – such as child’s education or marriage.
Don’t let mobility hinder you
Individuals can open a PPF account at any branch of State Bank of India, its associated banks, certain nationalized banks, and the post office. If shifting residence, intra city or to another city, the account can be transferred to a bank or “account office” that the account holder chooses.
If an individual attains the non-resident Indian, or NRI, status after the account has been opened and is functional, he can continue with the account till maturity (though the money cannot be repatriated).
Frankly, there is no reason not to open a PPF account.