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Small savings: Strategies for the future!
October 04, 2004 15:20 IST
Take a random survey and ask a group of individuals what investment options they would choose if they had to invest Rs 10,000. The most likely answers you will get are NSC, PPF and KVP; while a discerning minority may vote in favour of mutual funds and equities.
Despite the presence of alternate investment options, small savings schemes continue to be the preferred choice for a sizeable chunk of the investing population.
The high safety levels coupled with the attractive returns make small savings schemes a 'must-have' proposition for most investors.
Of late, these attractive returns have been the subject of scrutiny and debate. Small savings schemes cause considerable fiscal stress to the government and steps have been taken towards rationalising them.
The Rakesh Mohan Committee report on small savings schemes, which was recently made public, has proposed some stringent recommendations. The primary one being making the interest rates offered by such schemes linked to market rates.
Some of the recommendations like scrapping of the 6.5% (Tax Free) GOI Bonds and deposit schemes for retiring government and public sector employees have already been implemented.
Another interesting but often-ignored aspect pertaining to small savings schemes has been their nuances. All small savings schemes tend to be characterised as the same despite the fact that they vary on parameters including tenure, returns and liquidity. There is much more to these schemes than just the safety and returns.
At this stage the key lies in gearing up for the future by making investments in schemes that suit you the best. Remember, investments made in small savings schemes at this stage will be insulated from future changes (except in the case of PPF where the rate is revised regularly).
In light of these aspects we profile some of the popular schemes and determine in whose portfolio they should find a place.
1. Public Provident Fund (PPF)
The PPF ranks as one of the most attractive schemes within the gamut of small savings. It presently offers a return of 8% pa and runs over a 15-Yr period. The scheme promotes regular savings by ensuring that contributions are made every year to keep the account active; these contributions can vary from Rs 500 to Rs 70,000 pa.
Liquidity
PPF doesn't score too well on this parameter. Withdrawals are permitted only after the expiry of 5 years from the end of the financial year in which the first deposit was made. Also the amount which can be withdrawn is a factor of the balance present under the PPF account.
Tax
Investors are entitled to claim tax-benefits under Section 88 for deposits made up to Rs 70,000 pa in the PPF account. Also the interest is exempt from tax under Section 10 of the Income Tax Act.
What is the future likely to be?
The Rakesh Mohan Committee goes soft on the PPF and terms it as a long-term savings scheme providing old age income security, hence considers "it desirable to continue the scheme in its present form for some time".
Hence if the recommendations are accepted "in toto" the PPF could continue to provide the same attractive returns. One reason for this could be that the rate of interest offered by the PPF is not locked in. So today you could be getting 8% pa on your outstanding balance, and the next year, it could well be 7% pa.
Who should invest?
PPF will prove to be a smart investment option for investors who have age on their side and for whom liquidity is not a concern. Getting invested even at this stage can prove to be a smart option.
But investors should factor in the point about the returns not being locked in. Also, in case your account is nearing maturity, irrespective of your age, you may do well do contribute the maximum possible.
2. National Savings Certificate (NSC)
NSC is another attractive instrument offering a return of 8% pa. Investors are required to make a single deposit and the interest component is returned along with the principal amount on maturity. NSC has an edge over its peers on account of a relatively lower tenure i.e. 6 years.
Liquidity
This is one area where the NSC scores rather poorly. Premature encashment of certificate is allowed under specific circumstances only, such as death of the holder(s), forfeiture by the pledgee or under court's order.
Tax
Investments in NSC enjoy tax-benefits under Section 88 of the Income Tax Act. The interest is entitled for exemption under section 80L of the Income Tax Act. An added incentive is that the accrued interest is automatically reinvested, and qualifies for benefit under Section 88.
What is the future likely to be?
The Rakesh Mohan Committee recommends the discontinuation of the NSC.
Who should invest?
Investors who offer more weightage to tax benefits vis-�-vis other factors like liquidity should consider investing in the NSC. The advantages of getting invested in NSC at this stage will only get magnified, should the scheme be scrapped in accordance with the recommendations.
Small savings schemes at a glance
3. Kisan Vikas Patra (KVP)
KVP falls under the category of small saving schemes which don't offer any benefits under the Income Tax Act. The scheme runs over a tenure of 8 years and 7 months (which is a fairly longish horizon) and doubles the amount invested. This makes the return one of the most attractive one amongst its peers.
Liquidity
Investors are permitted to liquidate their investments in KVP any time after 2.5 years from the investment date. However a loss of interest has to be borne. In terms of tenure for withdrawal (2.5 years) it scores far better than the NSC and PPF on this parameter.
Tax
As stated earlier, investments in KVP don't offer any tax benefits. The interest on investments is fully taxable as well.
What is the future likely to be?
Like the NSC, the axe could also fall on the KVP, since the committee has recommended its discontinuation as well.
Who should invest?
Investors whose priority is earning attractive returns while maintaining a reasonable degree of liquidity should consider investing in the KVP. Also KVP will hold appeal for investors in cases where tax benefits are not a priority.
4. Post Office Monthly Income Scheme (POMIS)
As the name suggests, this scheme provides monthly income (at 8% pa) to investors. On competition of 6 years, a 10% bonus on the principal sum is provided.
Liquidity
POMIS offers investors an exit option after 1 year from the investment date. However the catch lies in penalty clause. An exit after 1 year would also entail a loss of 5% of the amount invested.
As a result, while the investor would not suffer any loss in interest earnings, but the loss of principal can be a significant one (especially for investors with high investments). Investors have to wait for a 3 year period if they wish to liquidate their holdings without any loss of principal.
Tax
The interest on investments as well as bonus received on maturity qualifies for tax benefits under Section 80L of the Income Tax Act.
What is the future likely to be?
The Rakesh Mohan Committee recommends that the scheme should be continued in its present form, however going forward returns should be aligned to the market rates.
Who should invest?
POMIS is best suited for investors like retirees who are looking for regular returns. The combination of assured returns with tax benefits makes POMIS an attractive proposition.
Read more about the Rakesh Mohan Committee recommendations
5. Post Office Time Deposits (POTD)
Post Office Time Deposits are essentially fixed deposits of varying tenures offered under the domain of small saving schemes. These deposits are available for periods ranging from 1 year to 5 years with the interest rates varying correspondingly. Interest payments are made annually. POTD have emerged as one of the most favoured instruments in recent times.
Liquidity
POTD scores favourably on the liquidity front. Investors can exercise the exit option within 6 months without receiving any interest (1-Yr lock-in for exit with interest receipt). However the penalty clause is applicable depending on the interest rates offered by the time deposit. A flat penalty of 2% is deducted from the relevant rate in case of premature withdrawals.
Tax
Interest on POTD is eligible for tax benefits under Section 80L of the Income Tax Act.
What is the future likely to be?
As is the case with POMIS, the committee recommends that POTD should continue in their present form. However it is proposed that interest rates must be aligned with market rates.
Who should invest?
POTD fit into most portfolios across investor classes. All an investor has to do is select the appropriate tenure for which he wishes to make the investment. The annual interest payment option along with flexible investment tenures ensures that POTD towers above most schemes over the short and medium-term horizon.
6. Senior Citizens Savings Scheme (SCSS)
Ironically the "new kid on the block" among small savings schemes, is a scheme reserved for senior citizens. The scheme has been reserved for citizens above 60 years of age, albeit citizens above 55 years can invest in the same subject to certain conditions being fulfilled. SCSS offers a return of 9% pa, making it a must have proposition for the target audience. The SCSS in tandem with the POMIS can prove to be a very lucrative option for senior citizens who need regular income without taking on any risk.
We believe the process of rationalising small savings schemes has begun, and will continue. However what is debatable is the pace of these reforms. Scrapping of certain schemes as suggested in the Rakesh Mohan Committee report indicates that it could be the roadmap for future changes.
From the investor's perspective getting the right allocation within the small savings schemes is vital. However if the future changes can be factored in, it would be a case of having the best of both worlds.