In small savings, look at returns, tax benefits

If the news that the Employees' Provident Fund (EPF) rate has been reduced to 8.25% from last year's 9.50% depressed you, the increased rates for small savings schemes are likely to compensate for it. The government has increased rates for small savings instruments by 20-50 basis points (100 basis points is 1 percentage point) for 2012-13.

If the news that the Employees' Provident Fund (EPF) rate has been reduced to 8.25% from last year's 9.50% depressed you, the increased rates for small savings schemes are likely to compensate for it. The government has increased rates for small savings instruments by 20-50 basis points (100 basis points is 1 percentage point) for 2012-13.

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Last year, the interest rate on small savings schemes were linked to government securities (G-secs) of similar maturity periods with a positive mark-up of 25 bps. So if G-sec yields X%, the rate of return in the case of say Public Provident Fund (PPF) would be X.25%. For Senior Citizen's Savings Scheme (SCSS), this mark-up is 100 bps and for the new National Savings Certificate (NSC) with a tenor of 10 years, the mark-up is 50 bps.

In case of instruments such as PPF, where you need to invest every year, the rate of return would vary every year, but in instruments where you make a one-time investment such as NSC, the return will remain fixed for the investment tenor.

Public Provident Fund

In 2011-12, PPF earns 8.60%, a 60 bps increase from the previous year, and in 2012-13, it will earn 8.80%, which is 20 bps more than the current year. It is a risk-free and tax-free product that is also capable of generating positive returns after accounting for inflation. PPF is an EEE (exempt, exempt exempt) vehicle. Contributions qualify for a deduction of up to R1 lakh, you pay no tax on interest and maturity proceeds are tax-free.

Other investments
National Savings Certificate (NSC): Here, your contributions qualify for 80C deduction up to Rs 1 lakh. Subsequently, even the interest that accrues every year and gets reinvested qualifies for the 80C deduction. But the interest income in the last year is taxable at your marginal income-tax rate. So if you have exhausted your section 80C limit, investing in NSCs doesn't make sense.

Fixed deposits: Even five-year post office FDs have the same problem; the contributions enjoy a tax deduction but the interest is taxable. For 2012-13, the five-year deposit will earn 8.50%. So if you are in the highest tax bracket of 30.90%, your effective yield is 5.87%. In comparison, five-year bank FDs that qualify for section 80C benefits are better as they currently yield a higher return of 9.50%.

Senior citizen's savings scheme: The rate of interest for SCSS will be 9.30% for 2012-13. It is paid quarterly. SCSS also qualifies for a tax deduction under section 80C. But the interest is taxable.

Monthly income scheme: The rate of return will be 8.50%. The interest is paid monthly. Not only is the return low, it does not enjoy any tax benefit. The rate of 8.50% is not the best bet.