The mind-set of a fixed income investor is easy to decipher; preservation of capital dominates with a guaranteed income stream.
In the tax saving arena, such investors gravitate towards the Public Provident Fund (PPF) and the National Savings Certificate (NSC), since both represent security of principal and some kind of assured return.
It is natural to feel inclined towards either, with no strong preference, since the similarities abound.
Both are sovereign backed investments, which means they are is issued by the national government of a country. This points to the highest safety since the government will not default on its obligations.
Investments in both offer a deduction under Section 80C of the Income Tax Act.
The rate of interest is fixed every quarter using the yield of G-Secs as a base. Currently, both offer 7.6% per annum and are compounded annually (NSC was earlier compounded half yearly).
So how does one make a choice between the two?
On taxation, PPF scores
As mentioned earlier, the amount invested is eligible for a deduction under Section 80C. This is applicable to both. However, PPF scores because the interest earned is tax-free. Not so in the case of NSC where the interest is taxed.
For tax purposes, income is classified under 5 heads:
1) Salary
2) Capital Gains
3) Profit from business or profession
4) Rent from house
5) Income from other sources. It is under the latter that interest income is taxed.
On the other hand, the interest earned in PPF is tax free. The interest is added to the principal investment and compounded, and the accumulated amount is also exempt from tax on maturity. This makes it an EEE investment; which is an acronym for Exempt, Exempt, Exempt.
Your investment is allowed for a deduction. So, you don’t have to pay tax on part of the income that equals the invested amount.
You don’t have to pay any tax on the returns earned during the accumulation phase.
Your income from the investment would be tax-free in your hands at the time of withdrawal.
Limit
In the case of PPF, the upper limit is identical to the limit under Section 80C – which is Rs 1.50 lakh. You cannot invest more than this amount in any single financial year.
The NSC has no upper cap in terms of the investment to be made. An individual can invest however much he chooses to in this investment. The NSC is issued in denominations of Rs 100, Rs 500, Rs 1,000, Rs 5,000 and Rs 10,000. Any number of certificates in any denomination can be purchased. However, the tax deduction limit under Section 80C stays constant.
One time vs. Ongoing
The PPF account has to be maintained over the span of 15 years with a minimum deposit of Rs 500 per annum. So even if you do not max the Rs 1,50,000 limit, put in at least the minimum to keep the account operational.
In the case of NSC, you buy the certificate and hold it till maturity.
When you buy the NSC certificate, the interest rate prevalent at that time applies. The investment is then locked up for its relevant duration for that interest rate. For example, let’s say you buy a Rs 1,000-denominated NSC when the interest rate is 7.6% per annum. The next quarter, the rate drops to 7.3% per annum. Your investment will be locked in at 7.6% and unaffected by the new rate. The new rate will be applicable to fresh investments.
Not so in the case of PPF where the interest is adjusted every quarter and applicable to the entire amount in the account.
Portfolio role
The 5-year NSC can be used to target a short-term goal (the 10-year tenure has been discontinued). For instance, if you are planning on making the down-payment towards a home around 5 years down the road, this is an excellent way to block your money. Or, saving for an extended holiday abroad. The key being, you want your money secure and within a fixed time frame.
The PPF is a long-term savings tool with complete tax benefits. If you commence the account when around 30 years of age, you can position it for, say, your child’s education. You can even position it for retirement since on maturity you can keep extending the account by 5 years.
As mentioned in Smart tax planning moves, keep your overall portfolio and goals in mind when making a call.
