PPF benefits: People often choose the Public Provident Fund (PPF) to save on taxes due to two main reasons: the yearly interest is tax-free, and there’s a compounding effect each year. The PPF’s 15-year duration boosts the compounding impact, especially in the later years of the investment period.
Additionally, the investment is deemed secure because the interest earned is backed by a government guarantee.
Starting from the financial year 2020-21, individuals can choose between the old tax regime, which includes deductions and exemptions under sections 80C, 80D, 24, and others, or the new tax regime, which excludes these benefits. Opting for the new tax regime means forgoing commonly used benefits, such as deductions for PPF investments, among others.
If you have opted for the old tax regime, it allows you to save taxes under section 80C of the Income-tax Act, 1961, by investing in PPF.
PPF returns
The interest rates for small savings schemes, including PPF, are connected to the yields of 10-year Government Securities (G-Secs) in the secondary market. Specific formulas determine mark-ups over the average yield of relevant G-Secs with comparable maturity for the previous three months, according to an ET report.
The central government reviews the interest rates for small savings schemes quarterly, adjusting them based on the G-Secs yields from the preceding three months. This approach, recommended by the Shyamala Gopinath Committee in 2011, ensures that the interest rates for small savings schemes stay linked to market conditions.
As of January to March 2024, the current annual interest rate for the Public Provident Fund is 7.1 percent.
To keep the account active, a minimum annual deposit of Rs 500 is necessary. However, there is a maximum limit for deposits in a financial year, restricted to Rs 1.5 lakh.
PPF taxation
The taxation of Public Provident Fund (PPF) follows the exempt-exempt-exempt (EEE) classification, offering triple tax exemption. This means that tax benefits are applicable during the investment phase, the accrual of interest, and the withdrawal period, making PPF one of the few investment products with comprehensive tax advantages.
As per section 80C of the Income-tax Act, 1961, investments made in each financial year can be deducted up to Rs 1.5 lakh. Moreover, the yearly interest earned is also eligible for tax exemption. Furthermore, the accumulated corpus becomes tax-free income upon maturity, resulting in complete exemption from taxes.
Read More: How to open a PPF account for tax exemption purposes? A step-by-step guide
Compounding in PPF
If the maximum annual investment of Rs 1.5 lakh is made for 15 years at an average interest rate of 7.6 percent, the accumulated corpus can reach approximately Rs 42.5 lakh. This underscores the potency of compounding, particularly over an extended period. Allocating the maximum possible amount in the initial years provides ample time for funds to compound and grow.
For instance, investing Rs 1 lakh annually for 15 years at an average interest rate of 7.6 percent per annum leads to an accumulated corpus of nearly Rs 28.5 lakh. In this corpus, the interest component amounts to about Rs 13.5 lakh, making up approximately 47 percent of the total.
Investing Rs 1 lakh in PPF for the first 10 years, with a yearly minimum deposit of Rs 500 to keep the account active, would result in an accumulated amount of nearly Rs 22 lakh by the end of the 15th year. In this situation, around 55 percent of the total is attributed to the interest. Even without making new contributions in the last five years, compounding adds interest annually to the previous year’s balance, showcasing how it significantly boosts the investment’s growth over time.
Maturity of PPF
After the initial 15-year period from the opening of PPF account, there is no requirement to close it. Instead, it can be extended indefinitely in blocks of 5 years, with the option to decide whether or not to make new contributions. During each extended period, individuals can make partial withdrawals once a year, offering flexibility to meet regular income needs. This feature enhances the versatility of the PPF as a long-term savings and investment option.
What you can doInvestors looking for stable returns and wanting to steer clear of the ups and downs of the stock market find PPF suitable. However, for long-term goals, especially when targeting a high inflation-adjusted amount, it’s recommended to explore equity exposure, says an ET analysis. This can be done through instruments like equity mutual funds, such as tax-saving Equity Linked Saving Schemes (ELSS), offering a potential opportunity for increased returns over the long term.
It may not be suitable to directly compare PPF and ELSS as they fall into distinct asset classes. PPF usually provides approximately 7.1% returns, while ELSS has historically yielded around 12%. While ELSS may result in a higher maturity corpus, it also carries more volatility compared to PPF, which is known for its lower volatility.
Read More: Laddering FD: This Technique Can Help You To Maximize Returns On Deposits
A wise approach includes spreading savings across both PPF and equities instead of depending entirely on one option. This strategy achieves a balanced portfolio, leveraging the stability of PPF and the potential for higher returns, albeit with added volatility, from equity investments.
