How the changes in Small Savings Schemes benefits investors

Last year when interest rates on small savings schemes & PPF were made market linked , many investors raised queries whether they will still be a good instruments to invest. For many years these schemes have been used in building a retirement corpus or to meet other long term goals such as children's marriage expenses and education. A sudden change in the rules has made investors rethink on these avenues.

The biggest change has been brought in the interest rates of these instruments. As per the revised structure, the rate of interest on all small savings schemes is now aligned with G-Sec rates of similar maturity, with a spread of 0.25% (Excluding 10 year NSC & SSC where spread is more).

The interest rates for every financial year will be notified before April 1st of that year.

Let’s look at how the changes benefit to the investors:

1. Public Provident Fund (PPF)- Public provident fund has been one of the most lucrative instruments among all class of investors. A 15 years scheme which enjoys EEE status is considered widely for various long term needs. Till last year this instrument was fetching a fixed interest of 8% p.a. But now the interest rate will be 25 basis points above the G-Sec rate and in March 2012 a rate of 8.8% was declared on for FY 2012-2013. The investment limit has also been raised to Rs 1 lakh which is a welcome move. Although rates have been made variable, it gives an opportunity to investors to earn more. Even if interest rates fall tomorrow one can expect good yield over the horizon due to tax free status. Even Direct Tax Code also wishes to continue the product with no changes. All these changes still benefit investors and the product holds good for long term planning i.e. planning for kids or retirement.

2. Senior Citizen Savings scheme (SCSS) - A spread of 100 basis points in Senior Citizen Savings scheme is boon for retirees when inflation is considered. The interest rate for FY 2012 is declared at 9.3% which is comparable to what bank FDs are offering today. Also cost of exiting the product (1.5% in 1st year & 1% in 2nd year) is lower than what penalty banks charges for closing FDs.  Coupled with tax benefit under section 80C the product hold good for investors. However, things can change post DTC as it may remove the tax advantage.

3.  National Savings Certificate (NSC)- The term has been reduced to five year and a new product with 10 year horizon has been introduced. The rate for FY 2012 is 8.9% for 10 year and 8.6% for 5 year. The interest received in NSC is eligible for Sec 80C benefit. Comparing both the options, only 10 years NSC yields higher for individuals in highest tax bracket due to higher spread of 50 basis points. Even after reducing the term, 5 year NSC scores lower when compared to bank FDs. This is primarily because in NSC interest is compounded half-yearly as compared to a bank FD which compounds interest quarterly. Weigh your options before considering this product.

4. Post Office MIS- Monthly interest is the attractive feature of the product. With maximum limit of Rs 4 lakh in single account & Rs 9 lakh in joint accounts the product is considered by senior citizens for regular income needs. The tenure of scheme is reduced to 5 years and the interest for FY 2012 is 8.6%.The biggest disadvantage is discontinuation of maturity bonus of 5% as it lowers the net earnings from the product substantially making it less attractive.

5. Post Office Time Deposit: One of the major positive changes apart from market linked interest is that the penalty on premature withdrawal has been brought down to 1% from 2%. Also, until now there was no interest paid on withdrawal between 6-12 months but with new changes even this interest will also be paid to investors. The interest for FY 2012 stands at 8.4%.The taxability of interest and no tax deduction on investment lowers the net yield from these deposits. The other disadvantage with this product is the inconvenience to investors as one has to visit personally the post office for making any transactions.

Investors will have to adjust to market linked interest rates. The element of certainty in growth which was there is no more. Now interest rates will have to be relooked every year and calculation of maturity amount will have to be done accordingly. Understand the changes clearly before making a decision. On risk return characteristics, PPF still holds good for planning your long term needs.

- Jitendra Solanki

The author is a Certified Financial Planner and Founder of JS Financial Advisors. You can reach him at jsfadvisors@gmail.com