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Saturday, February 27, 2016

Should you invest in PPF or NSC?

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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.

To start off with, let's look at the investment trinity. There are three guidelines on which you must evaluate every single investment: risk, return, liquidity.

In the case of PPF and NSC, both are backed by the government and so score high on the risk parameter. You can be pretty sure of getting your money back.

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 and the NSC IX issue is for 10 years.

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.

They continue to diverge on the return front too. Of course, they both offer fixed returns which are set at the start of the financial year but the similarity ends there. In 2012-13, the rate as fixed by the Reserve Bank of India, or RBI, was 8.8% per annum for PPF. It then got upped to 8.7% per annum and stays there this fiscal. Currently the rate for NSC is fixed at 8.5% (NSC VIII) and 8.8% (NSC IX) per annum.

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 account and you can keep adding to it.

The return in both cases is compounded and handed over on maturity. A apparent distinction is that the return is compounded annually in the case of PPF, but half-yearly where NSC is concerned. Once again, it puts NSC in a good light but the tax benefit nullifies the effect.

Let's say that you invest Rs 1 lakh in a 10-year investment earning 8.8% per annum. If compounded annually, you would end up with Rs 2,32,428. But if compounded half yearly you would earn around Rs 4,000 more (Rs 2,36,597) over a decade. But like I said, the tax impact gives it a different complexion.

Both instruments qualify for a deduction under Section 80C of the Income Tax Act. The maximum limit under this section is Rs 1.50 lakh. You can choose to invest up to that limit in either of the two instruments or both. (Or any other instrument under Section 80C).

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 as mentioned above, even though the return in NSC is compounded half yearly, the return is taxed which makes PPF a better tax-saving option but with a longer lock-in.

So how does one choose between the two?

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.

So if you have an ongoing PPF account, it would be better to keep investing in it since it also offers great tax benefits. However, if you foresee an expense exactly 5 years down the road, then you could consider a NSC with that very tenure. If you need the money 10 years down the road, then it would be wise to consider an equity linked savings scheme, or ELSS. This is a mutual fund which offers a tax benefit under Section 80C. After it completes the mandatory 3-year lock in, you could sell the fund units whenever the stock market is rallying.

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