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Wednesday, April 18, 2012

Retirement planning with the Public Provident Fund (PPF)

With the 50 bps cut in the repo and reverse repo rates announced by the RBI, fixed deposit rates in banks are likely to get revised downwards soon. No one really looks at bank fixed deposits as part of retirement planning anyway, since there are no tax benefits on the principal or the accrued interest.

For those who have recently entered the work force – whether in a job or a business - retirement planning may not be the top priority right now. But it should be. That is the best way to let the magic of compound interest work in your favour. The sooner you start saving and the longer you stay invested, the more money you will accumulate.

In this month’s guest post, Nishit extols the virtues of investing regularly in the PPF scheme to help accumulate a tidy amount after retirement.

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Today we re-visit a very old, boring and vanilla investment instrument called the Public Provident Fund (PPF). PPF is a Government of India scheme which is deployed through PSU Banks, post offices and some of the Private Banks.

The money is safe as per the Sovereign guarantee and cannot be attached by anyone even if someone is declared bankrupt. The proceeds are tax free and the amount invested is also tax free.

The last year brought about two very important changes in the PPF scheme: (1) the investment limit was raised from Rs 70000 per year to Rs 1 lakh; (2) the rate of interest is floating linked to the 10 year Government bonds. PPF will carry about 0.25% more interest than the average yield of the G-Sec. G-Sec yield typically is in the range between 7.75 % and 9%. Accordingly the PF rates have gone up to 8.6% and 8.8% in the 2 years.

I have enclosed the chart of 10 year G-Sec over the past few years and for most of the times it is ruling around 8%. The government will be very careful in letting the interest rate of PPF drop below 8% since it is a very sensitive issue politically. Many of the middle class voting public of India invest in the PPF. For the sake of calculation I have taken the interest rate as 8.2%.

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If one invests Rs 1 lakh (Rs 100,000) every year at the beginning of the year, after 20 years one will accumulate Rs 50 lakhs. Even if someone takes the interest rate as 8%, he will end up with Rs 49 lakhs.

PPF is definitely one of the pillars of investing for one’s retirement. The total amount becomes Rs 81 lakhs after 25 years. Now, taking into account inflation and the government dearness methodology Rs 100 after 25 years will be equivalent to Rs 500 today. So, you are left with a corpus equivalent to Rs 16 lakhs in today’s terms. That can provide a decent monthly income of Rs 12000 in today’s terms.

The other pillars of investment will be your equity portfolio and other savings. PPF is a simple, straightforward and tension-free way of preparing for one’s retirement.

The following table indicates the amounts accumulated after every five years:

Year Amount invested at the beginning of the year (Rs) Interest earned at the end of the year (Rs) Total amount accumulated (Rs)
1 100,000 8,200 108,200
5 589,000 48,300 637,300
10 14,62,500 119,900 15,82,400
15 27,57,850 226,150 29,84,000
20 46,78,850 383,650 50,62,500
25 75,27,650 617,250 81,44,900

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

6 comments:

Ajay said...

Hi,

For a NRI, SBI is offering 9.25% P.A interest on FD that is compouned quaterly. It is 2Lac invested today will fetch u 5Lacs after 10years. Is it not a good option? Even a RD of 10years fetch you a steady return of 9.25%? CFA's recommend 12% return for calcualtion pupose on equity. Is it not better to bet on majority of amount on 10Year FD and RD and invest a small amount on Equity Funds for your goals planning? Leave apart a good 2002 to 2007 period & 2009, equity funds have delivered absymal returns. While everyone talks of equity, remove those years, it doesn't even match FD returns!!! Like to have your thoughts on this tax free saving option currently available for NRI's. Investing directly in stocks is not everyones cup of tea.

Jasi said...

@Ajay,
What are the tax implications for NRIs? For us lesser mortals, post tax, FD's dont look as attractive.
As for equity, :) Well if you remove the other years, you are looking at access of 50-75% pa returns :)
I mean that is the thing with equities, give it a 10 year time frame and if you are smart about your investments, it is unbeatable.
My personal take :)

ps> Infact, religiously follow Subhankar Da's blog and you'd notice the change. :)

Ajay said...

Hi Jasi,

NRI FD investment done via NRE account is tax free (zero tax on capital and zero tax on gains). 9.25% compounded quaterly for 10years from SBI is currently on the offer. Well stocks are good it is not about stock versus FD. It is about a return on investment after 10years, without risking any capital and also tax efficient.

Nishit Vadhavkar said...

If the investment is tax free, then the FD scores over PPF.
For resident India, the FD returns get added to the income tax slab one falls in.
Also, many people dont have the discipline to save regularly. For such folks, this locked in amount is a boon.

Jasi said...

@Nishit and @Ajay,
Thanks for your responses.

Ok so of course if the NRI isnt filing returns in India, he isnt liable to be taxed, hence the interest from FDs here are tax-free. But I guess you would still need to show this interest income in the US while filing returns there. In which case, FDs and PPF both would be treated similarily.
Right?

Ajay said...

hi Jasi,

I m from gulf and in gulf there is no tax. NO tax on NRE accounts and deposits also in India.