Tag: small savings

How a small change in date can impact interest income

Personal Finance

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If you are grappling with low interest rates on fixed income products, you may want to do every little bit to enhance your interest income. For that, it is important to understand how interest income is calculated.

The date on which deposits and withdrawals are made in a month can have an impact on the interest income you earn. Here we talk about the interest calculation for a few fixed income instruments – Public Provident Fund (PPF), Sukanya Samriddhi Yojana (SSY), Post Office Savings Account (POSA) and Employees’ Provident Fund (EPF).

Post Office Schemes

PPF and SSY are two long-term saving products from the Post Office offering attractive interest rates today.

Both the accounts require minimum amount to be deposited every financial year (₹500 for PPF and ₹250 for SSY) to keep them active.

Under these accounts, the interest amount gets credited at the end of the financial year and compounding of interest happens annually. However, the interest is calculated for each calendar month on the lowest balance in an account between the close of the fifth day and the end of the month.

Say, the balance in your PPF/SSY account as on July 2021 end is ₹2 lakh and you plan to deposit ₹10,000 in August. If the deposit is made on August 6, the interest for the month of August will be calculated on ₹2 lakh only. The deposit amount of ₹10,000 will be considered for interest calculation only from the month of September 2021. If you slightly tweak the deposit date to some time before August 5, you can earn a slightly higher interest income on PPF/SSY. This may translate to a reasonably good amount over time due to the compounding effect.

The Post Office Savings Account (POSA) too comes with similar conditions. The interest, here too, is credited at the end of each financial year, but the lowest balance between the tenth and the last day of the month is considered.

Rules for POSA also state that on withdrawal of the entire balance interest on the corpus will be calculated up to the last day of the month preceding the month in which the account is closed. Thus, one can plan the withdrawals from POSA at the beginning of a month as you would have maximised the interest earnings at the end of the previous month.

Employees’ Provident Fund

If you are a salaried , both the employee and the employer together contribute 24 per cent of the basic salary plus dearness allowance on a monthly basis towards EPF.

On all the contributions made, interest is calculated from the first day of the month (succeeding the month of credit) to the end of that fiscal year.

For example, if, say, the EPF contribution for April 2021 is made by your employer to the EPFO towards the end of the April itself, then this contribution will earn interest for eleven months in the fiscal FY22 (May 2021 to March 2022). But say, the employer deposits the amount in the beginning of May 2021, then interest will be calculated only for ten months, that is, from June 2021 to March 2022.

Though credits to the PF account are not in your control, understand that your employer transferring the monthly PF contribution at the end of that relevant month is beneficial over transfer at the beginning of the next month.

On the other hand, in case of withdrawals, interest is calculated on the withdrawn amount up to the last day of the month preceding the month of withdrawal.

On maturity

You can consider continuing your investments in fixed-income products such as PPF/SSY and EPF account even after the contributions come to an end. This is because the interest rates offered by EPF (8.5 per cent for FY20), PPF (7.1 per cent now) and SSY (7.6 per cent now) have so far been attractive compared to other products considering the risk-return metrics.

When the subscriber retires after 55, interest will continue to be credited to the PF account until three years from the time fresh contribution to the account are stopped. Even when the EPF account becomes dormant (with no fresh contributions) before retirement age of 55, the account continues to be operative and interest will be paid until the subscriber turns 58, in most cases. In case of PPF/SSY, the account holder may retain his account after the minimum contributory period of 15 years, without making any further deposits upto 21 years from account opening in case of SSY or any period in blocks of five year in case of PPF and the balance in the account will continue to earn interest at the rate applicable to the scheme.

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All you wanted to know about 54EC bonds

Personal Finance

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A popular option for saving long-term capital gains tax on sale of property is section 54EC bonds. Investing in these bonds can help you make gains of up to ₹50 lakh per financial year from capital gains tax. However, there is a lock-in period of five years. This used to be three years earlier. These bonds carry interest, which is currently at 5 per cent and is taxable.

While these bonds are effective in saving tax, there is another option to consider. You have two choices: (a) save long-term capital gains tax by investing in 54EC bonds and lock in your money for five years or (b) pay the tax, keep your money liquid, and invest it in avenues yielding higher than 5 per cent.

Let us compare the returns from these two options.

Assume, for instance, that there is long-term capital gains of ₹50 lakh that is taxable, after indexation benefit as applicable. A sum of ₹50 lakh invested in 54EC bonds would fetch a defined return of 5 per cent per year. This coupon/interest is taxable at, say, 30 per cent (your marginal slab rate), ignoring surcharge and cess for simplicity. Hence your return, net of tax, is approximately 3.5 per cent. As against this, if you go for option (b), you pay tax on capital gains, which is taxable at 20 per cent if we ignore surcharge and cess, for simplicity. Subsequent to paying the tax of ₹10 lakh, what remains with you for investment is ₹40 lakh. Let us now look at a few options for investing ₹40 lakh.

Tax-free PSU bonds

Since there are no fresh issuances of tax-free PSU bonds and interest rates have eased, the yields available in the secondary market are lower than earlier. For our comparison, we assume a yield (i.e. annualised return) of 4.25 per cent for investing in tax-free PSU bonds. ₹50 lakh invested in 54EC bonds, compounding at approximately 3.5 per cent per year, grows to ₹59.38 lakh after five years. ₹40 lakh, which is the net amount that remains in case of option (b), invested at 4.25 per cent tax-free, grows to ₹49.25 lakh after five years. Hence, investing in 54EC bonds at 5 per cent (pre-tax) is a better option than paying the LTCG tax and investing the remaining amount.

Bank AT1 perpetual bonds

There is a negative perception about perpetual bonds after the YES Bank fiasco. The risk factors that got highlighted after the YES Bank AT1 write-off have always existed, but came into action and hit investors. Having said that, there are front line banks such as SBI, HDFC Bank and the like that are worth investing in.

The range of yields in bank AT1 perpetual bonds is wide. We assume 7.5 per cent to strike a balance between risk (higher yield but higher risk) and reward (lower yield but lower risk). Taxation at 30 per cent means a net return of approximately 5.25 per cent. Against ₹59.38 lakh in case of 54EC bonds, ₹40 lakh invested at 5.25 per cent grows to ₹51.6 lakh after five years. Though somewhat higher than the ₹49.25 lakh from tax-free bonds, this is lower than the ₹59 lakh from 54EC, bonds making the latter a better option.

Equity

It is not fair to compare investments in bonds with equity. However, to get a perspective we will do a comparison. We will talk of the break-even rate now. Let us say, equity gives X per cent return over five years, and that is taxable at 10 per cent, which is the LTCG rate for equity for a holding period of more than one year. If ₹40 lakh invested in equity yields a return of 9.15 per cent per year pre-tax, which is 8.24 per cent net of tax per year, it grows to ₹59.4 lakh after five years. Hence the break-even rate for ₹40 lakh to outperform ₹50 lakh over five years, at 3.5 per cent net of tax, is 8.24 per cent net of tax.

Conclusion

Equity returns are non-defined and the break-even rate calculated for this asset class to outperform 54EC bonds is 8.24 per cent net of tax. It is difficult for bonds as it will be possible only for a bond with inferior credit quality against a AAA rated PSU one. Equity or a riskier bond not being a fair comparison, it is advisable to save the tax and settle for 5 per cent by investing in 54EC bonds. However, liquidity is one aspect you may keep in mind — investment in 54EC bonds is locked in for five years.

The author is a corporate trainer (debt markets) and author

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