New Delhi: Public Provident Fund, or PPF, is the best tax saving scheme in India. And if you are in the high tax-paying bracket, it is the best fixed-income scheme also. In this article we analyse why, through a three-step approach.
Step 1: Evaluating Returns, Risks and Liquidity
- Returns: Best fixed-income yield, tax benefits
Eight per cent tax-free interest is effectively 12.85 per cent pre-tax interest if you are in the 30 per cent tax bracket and 11.25 per cent if in the 20 per cent tax bracket.
It is difficult to find fixed-income instruments (at the same low risk level) that can yield you comparable returns!
Two-pronged tax benefits
The eight per cent interest is totally tax exempt under Section 10 (11) of the Income Tax Act.
In addition under Section 80C, PPF contributions (aggregated with your subscriptions to other schemes that qualify for Section 80C benefits), are eligible for deduction upto a maximum of Rs70,000 per annum.
(For authors, musicians, and the self-employed, the rebate is higher at 25 per cent.)
- Risks: Lowest risk of default
An investment in the PPF is equivalent to the risk of lending to the government, and hence has the lowest level of default risk.
- Liquidity: Poor but loans/ partial withdrawals available
The one disadvantage of PPF is lack of liquidity. Partial withdrawals are allowed only from the sixth year onwards. However, loan facility is available from the third year.
Loan availability
You can avail of a loan against your PPF investment from the third to the sixth year. The loan will be available upto a maximum of 25 per cent of the balance in your account at the end of the second preceding financial year.
If you repay the loan in 36 months, interest will be charged at 12% p.a. Otherwise, interest will be charged on the outstanding sum at six per cent per month. A second loan can be obtained before the end of the 6th financial year if the first one is fully repaid.
Making partial withdrawals from the PPF account
Beginning the seventh year and every year thereafter, you are entitled to withdraw 50 per cent of the balance to your credit at the end of the fourth or the first previous financial year, whichever is lower.
This facility is primarily provided to increase liquidity. The withdrawn amount can be used for any purpose whatsoever.
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Step 2: Tips For Maximising Benefits And Returns
- Invest by the 5th of the month
Interest in your PPF account is calculated on the lowest balance between the close of the fifth day and the last day of every month and is credited to the account at the end of each financial year ie, on 31st March.
So if you invest by the 5th of the month, you will be eligible to interest for the full month in which you are investing.
- Tax rebate can be availed of by investing even in the 16th year
Although, PPF is theoretically a 15-year scheme, you can make your last contribution to PPF till the last day of the 16th financial year.
Your contribution to PPF on the last day of the 16th year may not get any interest, but you can claim a tax-rebate on the investment amount.
- Post-Maturity continuation
You could choose to extend your PPF account for a period of five years at a time, after the completion of its 15-year term. Such an extension is recommended for individuals who do not need this entire amount, nor have a better investment option.
If you choose to extend your account, you must submit Form H if you want to claim section 80C tax benefits on fresh contributions.
If you merely retain the balance in your account, without submitting Form H, you will continue to earn 8% p.a. tax-free interest until it is withdrawn.
If you continue with fresh subscriptions, you are entitled to withdraw upto 60 per cent of your balance at the beginning of each extended period in one or more installments, but not more than once a year.
If you merely retain the balance in your account, you can withdraw the entire sum in one, or more, installments, but again, but not more than once a year.
- Can be self-funding after year 7
The partial withdrawal facility of the PPF scheme enables you to derive the benefits of section 80C without investing any fresh capital.
Assuming you have decided to invest a fixed amount in PPF every year, from the 7th year onwards you can withdraw an amount equivalent to your annual investment from your accrued PPF account, and deposit the same back as your contribution for that particular year.
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Step 3: The Process
- Eligibility
All salaried and non-salaried individuals, Hindu Undivided Family (HUF) and NRIs can invest in PPF.
Only one account can be opened per individual/ HUF, joint accounts are not allowed. Contributions in the names of spouse and children qualify for the rebate, but the investment will be deemed as a gift.
- Investment amount and mode of payment
Contribution to PPF can vary from year to year, at minimum Rs500 and maximum Rs 70,000 per year. The limit of Rs 70,000 is applicable to the aggregate of your investments in all the schemes that qualify for Section 80C benefits.
Subscription to the PPF account can be in multiples of Rs5 and paid in lumpsum or in installments (even more than one in a month but not exceeding 12 in a year).
Credit to the PPF account is on the date the cheque is presented and not on the date of clearance, unless the cheque bounces.
- Do you have to invest every year?
If the holder fails to subscribe the minimum Rs 500, the account is considered as discontinued. Interest will continue to accrue and paid at the end of the term ie, 15 years. Loans and withdrawals will not available.
The default can be condoned on payment of a fee of Rs.10 for each year of default, along with arrears of subscription of Rs 500 for each such year. An account holder in possession of a discontinued account can open a new account.
- Where can you apply?
At the branches of State Bank of India and its subsidiaries, some branches of some nationalised banks, and all the head post offices in India.
- When can a PPF account be closed?
On completion of the term (15 years) the PF account can be closed. Alternatively, it can be continued for a period of 5 years at a time, with or without contribution. To seek the option to continue, submit Form H.
- How can the nominee claim dues from the PPF account?
The nominee can claim dues on demand. However, the balance, if not withdrawn, continues to earn interest. Where there is no nomination in force, the balance will be paid to the legal heirs on production of succession certificate/probate.
To mitigate hardships, if the balance is less than Rs1 lakh, it will be paid to legal heirs on production of i) a letter of indemnity, ii) an affidavit, iii) a letter of disclaimer and iv) the death certificate.
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