The clock is ticking for Section 80C contributions—you have until March 31, the end of the financial year.
At first blush, it appears deceptively simple. Deciding on what to invest in might seem like one of those tasks that you should be able to knock off in 10 minutes— pick an investment, fill out the form, and submit a cheque. But some important decisions are embedded in those simple tasks: whether to choose the Public Provident Fund, or PPF, as against a National Savings Certificate, or NSC, for example.
Both offer a tax break under Section 80C of the Income Tax Act, which means that you can get a tax deduction up to Rs 1,50,000. But how does each size up in terms of an investment?
To start off with, let’s look at the investment trinity. There are three guidelines on which you must evaluate every single investment: risk, liquidity, return.
Risk
In the case of PPF and NSC, both are backed by the government. You can be pretty sure of getting your money back. No risk there.
Liquidity
On the liquidity front, there is a fair amount of disparity. Agreed, both have fixed tenures. But the NSC does show up in a more favourable light simply because of the lower lock-in period. The NSC VIII issue is for 5 years. The NSC IX issue with a lock-in period of 10 years was discontinued in December last year.
The tenure of PPF is much longer at 15 years and can even be extended by a block of 5 years on maturity. But worth noting is that after the third financial year, excluding the year of the deposit, an investor is allowed to take a loan on his investment. Partial withdrawals are permissible after the expiry of the fifth year from the date that the initial subscription is made. But worth noting is that the long tenure makes PPF an excellent long-term savings tool. (Read: How to position PPF in your portfolio).
Return
Both offer fixed returns which are set at the start of the financial year. However, going forward, they will be recalibrated on a quarterly basis. The current rate for NSC and PPF is 8.5% and 8.7%, respectively.
In the case of NSC, the rate of return is locked at the time of investment and during the tenure of the investment it remains insulated from any changes in rates. That is because once you buy a NSC, you cannot continue to add to that particular investment certificate. If you want to increase your exposure, you will have to buy another. In the case of PPF, it is an ongoing account that needs to be maintained by depositing a minimum amount every financial year. So the return on your PPF account will vary over time.
The return in both cases is compounded and handed over on maturity. A glaring distinction is that the return is compounded annually in the case of PPF, but half-yearly where NSC is concerned. That put the NSC in a more favourable light. However, going forward, from April 1, 2016, bi-annual compounding of interest for NSC will no longer exist, and it will be done on an annual basis. So in this aspect - annual compounding of interest rate - PPF and NSC will no longer differ.
So, barring the lower lock-in period, NSC has no benefit over PPF – the return is currently marginally lower, both are compounded on an annual basis, and in the case of PPF the interest earned is not taxed.
PPF offers you a deduction all the way and is known as EEE – implying exempt-exempt-exempt. What this means is that you get a deduction when you invest under Section 80C, the interest earned every year is exempt from tax, and the entire amount at maturity (principal + interest earned) is also exempt from tax. Not so in the case of NSC where the interest is taxed.
So how does one choose between the two keeping in mind their similarities?
- Backed by the government so capital is secure
- Interest is guaranteed
- Interest which was set every year will now be revisited every quarter
- Return is compounded annually
If you already have a PPF account, you would know that you have to invest at least Rs 500 every year to maintain the account. In fact, you can invest up to 12 instalments in one financial year as long as the totality of investment does not exceed Rs 1.50 lakh.
The NSC is a one-time investment. The investment can start from as low as Rs 100 and there is no maximum limit. However, once you touch the limit under Section 80C (Rs 1.50 lakh), the investments in NSC do not qualify for a tax deduction.
The PPF is a better investment. So if you have an ongoing PPF account, it would be better to keep investing in it since it is tax free all the way.
However, if you foresee an expense around 5 years down the road, then you could consider just putting in the basic to keep your PPF account running and invest in NSC since the tenure is more suitable. You can be sure of reaching your goal since the return is guaranteed and the principal will be safe. As we mentioned in Be holistic in your tax planning, invest not just to save tax, but keep your overall portfolio and goals in mind.
This article is part of a series on tax planning: