Small-saving schemes turn attractive after March-end rate hike: Here’s what you should do

The government hiked the interest rates on small-saving schemes on March 31.

It’s party time for fixed-income investors.

On March 31, the government hiked interest rates on small-saving schemes. Popular saving schemes like the Senior Citizens Savings Scheme (SCSS), National Savings Certificate (NSC) and Post-Office Monthly Income Scheme (POMIS) saw rates go up by as much as 70 basis points. One-hundred basis points are equivalent to a percentage point.

This is the third successive hike in small-saving scheme rates starting from the October-December 2022 quarter (see table for the latest rates).

However, the Public Provident Fund’s (PPF) interest rate was kept steady at 7.1 percent.

Still, government guarantee and income-tax deduction benefits by way of Section 80C make small-saving schemes a compelling choice.

“The intent of these schemes is to provide a safety net to the middle class backed by government guarantee. It is difficult for other debt products to compete with them, especially with the tax arbitrage with debt funds and high-value insurance policies gone,” says Ashish Shah, Founding Director, WealthFirst.

Also read: Missed the April 5 PPF deadline? Don’t fret; you won’t lose much

Small-saving schemes versus bank deposits

In line with the successive repo rate increases by the Reserve Bank of India from May 2022, when banks began to raise deposit rates, the small-savings rate hikes were a bit slow.

But over time, small-saving schemes have caught up. Aside from the recent rate hikes in small-saving schemes, the removal of the long-term capital gains and indexation benefits from debt funds have removed the tax arbitrage. Insurance policies (high-value life insurance and unit-linked plans) have also lost their attraction after Budgets 2022 and 2023.

For non-senior citizens, there is very little to choose between bank fixed deposits (FD) and small-saving schemes. For example, the State Bank of India (SBI) offers 6.8 percent and 7 percent on its 1-year and 2-year deposits, at present. The post office Time Deposit offers 6.8 percent and 6.9 percent, respectively. But compared to SBI’s 6.5 percent for non-senior citizens on its 3-year and 5-year deposits, the post office offers a higher rate of 7 percent and 7.5 percent, respectively.

A vast majority of private and public sector banks would find it hard to beat the 5-year post office Term Deposit rate of 7.5 percent. Also, unlike small-saving schemes, bank FDs (including those from small finance banks) are insured only up to an amount of Rs 5 lakh by the Deposit Insurance and Credit Guarantee Corporation.

When it comes to senior citizens, SBI’S 1-year and 2-year FD rates of 7.3 percent and 7.5 percent, respectively supersede the post office Term Deposit rates. But the bank’s 7 percent and 7.5 percent (the latter includes an extra 0.50 percent under SBI’s We-care deposit scheme), respectively on its 3-year and 5-year deposits match the post office Term Deposit rates.

While many other banks are offering higher rates than SBI, the public sector lender offers the closest comparison with the government-backed small-saving schemes on credit quality.

At an 8.2 percent interest rate after the hike (up from the earlier 8 percent), the SCSS continues to be among the best options for senior citizens wanting to save for the long term and wishing to get regular income. No 5-year bank FD barring that from Fincare Small Finance Bank surpasses the SCSS’s rate of interest. A few banks are offering a higher rate for FDs under 5 years.

The catch, as always: only those above 60 years of age, and certain retired civilian and defence employees above 55 years and 50 years of age, respectively and below 60 years of age, can invest in the SCSS. The scheme has a 5-year lock-in period and makes quarterly interest payouts.

Both the 5-year post office Term Deposit and the SCSS qualify for tax deduction under Section 80C of the Income Tax (IT) Act. Under this section, certain expenditures and investments of up to Rs 1.5 lakh per financial year are eligible for deduction from your total taxable income. As per this section, if any amount (including interest) is withdrawn before 5 years, then the withdrawn amount will be treated as the assessee’s income and will be taxed as such.

Also, unlike bank FDs which come in a range of tenures, post office Term Deposits come with only 1,2,3 and 5-year maturities.

No need for regular income?

For those who do not require a regular cash flow, the NSC which offers 7.7 percent (April-June 2023 quarter) and comes with a 5-year lock-in makes for a good investment. The NSC also qualifies for deduction under Section 80C of the IT Act. While the NSC offers 20 basis points over the post office’s 5-year term deposit, the interest is paid out only on maturity and not annually. The NSC cannot be closed prematurely before 5 years except for in situations such as the death of the account holder/s.

In fact, for those with a far longer investment horizon and no need for regular interest income, the PPF and the Sukanya Samriddhi Account Scheme (SSAS) are two stand-out options.

The interest rate on the PPF was left untouched at 7.1 percent in last week’s quarterly rate revision. “The PPF is the most popular small-saving scheme. While the PPF interest rate is formula-based (set at 25 basis points above the 10-year G-Sec yield, as are other small-saving scheme rates), the government has refrained from making frequent changes to it in line with changing G-Sec yields,” says Kirtan Shah, Founder and CEO, Credence Wealth. The scheme enjoys EEE (exempt, exempt, exempt) status. That is, investments into PPF are eligible for Section 80C deduction under the IT Act, and both interest and accumulated corpus are exempt from tax. Mrin Agarwal - Founder Director - Finsafe India says, “There is no comparable product to the PPF which is a very good option for conservative investors. While insurance products may have a similarly long tenure, they have some element of equity and offer lower returns of 4-5 percent.”

The SSAS is the only other scheme apart from the PPF that enjoys EEE status. The interest rate on it was hiked from 7.6 percent to 8.0 percent for the April-June 2023 quarter in the latest quarterly review. The condition – only the guardian of a girl child below the age of 10 years can invest in this scheme in the child’s name.

Also read: Why are you investing in National Pension Scheme? PFRDA wants to know