Besides being an ace tax-saving tool, PPF provides a disciplined and steady approach to savings. For those who have missed it, it's not too late to start investing in a PPF
JANUARY calls for the revelries in the new year but it also reminds one about the investments to be done to avail tax benefits before the financial year comes to an end. The most commonly known options for tax planning are equity linked schemes of mutual funds, home loans, tax-free bank deposits, public provident fund (PPF) and national savings certificate (NSC), among others. However, there are certain instruments that need to be looked at schemes that go much beyond just being a tax shield. For example, PPF not only provides tax benefits but also serves as a retirement planning tool for those private sector employees and self-employed who don't have the advantages of an employer-provided retirement benefits such as employee provident fund (EPF), gratuity and pension. In an endeavour to help our readers choose between various investment options that would provide them tax incentives as well, we at ET Intelligence Group decided to explore the Public Provident Fund in detail.
"The most powerful force in the universe is compound interest," said Albert Einstein, and PPF woks on the same principle. A systematic and orderly approach to investment in PPF can build a large retirement corpus. PPF is a government-backed scheme, which can be started with a minimum yearly subscription of as low as Rs 500 to as high as Rs 70,000. This comes easy on the pocket, as one does not need to deposit a huge chunk of money at one go. Infact no lender can claim an individual's PPF money even in the event of bankruptcy.
The interest earned on the PPF subscription is compounded and is calculated on the lowest balance between the fifth and the last day of the calendar month and is credited on 31st march of every year. The entire balance that accumulates over time is exempt from tax at maturity. However, under the new tax code, which is yet to be approved, it is taxable on maturity.
A flip side is that PPF is an extremely illiquid investment instrument. Its long lock-in period works out to 16 years since the last contribution is made in the 16th financial year. However, one gets the facility to withdraw money from his PPF account only after the fifth financial year. Withdrawal is allowed up to 50% of the balance in the fifth year or the year preceding, whichever is lower.
After the end of the 15-year period (actually 16 years), the PPF account can be extended for 5 years, as long as the individual wants to stay invested. In fact, one can also take a loan from the PPF account from the third year of opening the account to the sixth year. So, if the account is opened during the financial year 2009-10, the first loan can be availed during financial year 2011-12 (the financial year is from April 1 to March 31). The loan amount will be up to a maximum of 25% of the balance in the account at the end of the first financial year. One can make withdrawals from the sixth year.
To understand the advantage of compounding interest in the scheme, let us take a case where a 25-year-old individual starts investing Rs 5,000 every month in his PPF account. At 8% compound interest, his balance at the end of the first year would be Rs 62,664 and at the end of the fifteenth year it will swell up to Rs 17.4 lakh. This money could either be used to repay home loan or can continue to earn interest till the account is closed. He can even continue to extend the account for another five years and the amount received at the end of that time would be Rs 29.6 lakh. If he goes for another extension of five years, it will take the final account balance to Rs 48 lakh at the end of the stipulated period. The individual will be 51 years old at that time with nine more years of working life left before he retires.
Thus, PPF not only provides tax benefits but also helps develop a disciplined approach to saving. Therefore, it is never too late to start investing in PPF.
