Post-office savings get a new stamp :BLine

While passive investors can still park funds in post-office schemes, those looking to maximise gains will have to be more nimble on their feet.

Come December 1, post-office savings products are set to offer higher interest rates. While this announcement has been cheered by investors, it may be premature to rejoice based on this proposal alone.

First, if you have read up a bit more, you would know that these new rates are not really ‘fixed' for many years, as was the case so far. The interest rates for a five-year time deposit, for example, will no longer stay put at 7.5 per cent. A new rate will be announced on April 1 each year, and this rate will be linked to the average yield on a five-year government security during the previous calendar year (actual rate will be 25 basis points higher than average yields).

Today, the proposed rate on a 5-year deposit is 8.3 per cent. But it so happens that these changes have come at a time when market interest rates may be at their peak, making the picture look rosy. If market rates plummet later, so will the interest rates on your post-office savings.

Wind out of popular schemes

This is not the only tweaking these products have undergone. Other changes may force investors to reconsider whether they are still attractive at all. Consider the Monthly Income Scheme (MIS). As on March 31, 2011, MIS (outstanding of about Rs 2,18,674 crore) were the top small-savings product, constituting 35 per cent of the total outstanding of all small savings schemes put together. Aside from being popular for providing a steady stream of cash-flows every month from an initial investment, the MIS is considered an alternative to bank fixed deposits. For example, an investment of Rs 4,50,000 (upper limit) in an MIS, at 8 per cent, brings in Rs 3,000 interest every month. If this interest was invested in a post-office recurring deposit (RD) giving 7.5 per cent interest, the gain at the end of a six-year tenure, along with a bonus of 5 per cent, works out to Rs 49,254 per annum, or a return of 10.94 per cent (pre-tax).

Thus, this proved to be a good alternative at all times for people who had surplus cash to invest. More so, when long-term fixed deposit rates were much lower. Now, apart from the fact that the interest rates will change every year, there are two other changes to this scheme. One, the tenure is reduced to five years. Two, the bonus component is out. An immediate check at the current MIS (8 per cent) and RD (7.5 per cent) rates but with a five-year tenure and no bonus shows that the return from a MIS plus RD strategy falls from almost 11 per cent earlier to only about 8 per cent now. Besides, investors will also have to brace for year-to-year volatility, not only in the MIS rates but also RD rates.

Even if you lock into an MIS at an attractive rate, such as the proposed 8.2 per cent, returns on your recurring deposit investments from this cannot be locked in and will vary each year, making your ‘effective return' calculation go haywire.

Similarly, the Kisan Vikas Patra (KVP), forming 25 per cent of the total outstanding as at March 2011, has been another popular scheme.

Kisan Vikas Patra

Attributes such as free transferability, no limits on total investment, absence of TDS (tax deduction at source) on the interest amount, in addition to a promise of doubling investment in eight years and seven months, made KVPs an instant hit. Investors with income below taxable limit didn't have to worry about filing a return to claim refund of the TDS. But a wide usage of the KVP for parking unaccounted money, (given its opaque nature) has prompted the government to discontinue the scheme.

The withdrawal nevertheless narrows the choices for genuine investors, especially seniors, looking for risk-free investment options, which also promises good returns. There could, however, be a small window of opportunity in the next two days. As all the changes will take effect only on December 1, KVP sales would be discontinued only from November 30.

Calls for active money management

To give you the choice to pull out your money, schemes like the MIS, Senior Citizens' Savings Scheme, RD and time deposits already allow premature closure /withdrawal with a penalty. Now, with interest rates set to become volatile, you may be forced to take stock more often if rates turn really unattractive.

For example, if the MIS returns are unattractive and you can take some risk, you can consider investing at least a part of the amount in MIPs (Monthly Income Plans) of mutual funds. Offering a monthly dividend payout, these funds invest in short- and long-term fixed income instruments issued by governments or corporates, debentures and commercial paper. They also have a 15-20 per cent exposure to equities to provide some push to your returns (with additional risk!).

On that note, to enable you more actively manage your money, the government has lowered the burden on withdrawal of 1, 2, 3 and 5-year deposits. Premature withdrawal will now be allowed at a one per cent lower rate (2 per cent lower earlier) than the time deposits of comparable maturity. For premature withdrawals between 6-12 months of investment, Post Office Savings Account interest of 4 per cent (nil, earlier) will be paid.

There is also an interpretation that for schemes that require recurring investments, such as the PPF, every year's investment would earn the same year's rate of interest throughout the tenure of the PPF. If this is valid, it would make sense to invest the maximum possible amount when the PPF interest is high at 8.6 per cent from December 1- March 31, 2012 and then take a call on how much to invest the following year, based on the rates offered. This, again, calls for active management.

Saving for retirement

The new rules, however, seem to discourage liquidity for PPF, having raised the interest rate on loans from PPF from 1 to 2 per cent. This may be because the government wants people to look at it from a ‘saving for retirement' point of view. This is supported by the fact that the annual ceiling for investment in PPF has been raised from Rs 70,000 to Rs 1,00,000.

Two other facts also show that the government is trying create a ‘social security' net. One, the proposed introduction of a 10-year NSC instrument. NSCs, again, are locked in and don't generally provide a premature encashment facility. Two, the higher spread for the interest rate on this new NSC ( 50 basis points over g-sec rates) and the Senior Citizens' Savings Scheme (100 bps spread)

In all, passive investors looking for a reasonable risk-free return, can still park their funds in post-office schemes. But those investors looking to maximise returns or beat inflation will now have to be more nimble on their feet.

Still attractive?

Investors will feel the pinch from fluctuating interest rates more when the tax impact comes into the picture. Interest on the Monthly Income Scheme, Recurring Deposit, Time Deposits and Senior Citizens' Schemes (SCSS) are all taxable, and at times when interest rates are low, the post-tax returns will be even lower.

Unlike the 5-year time deposits and SCSS, the others don't qualify for deduction on initial investment under Sec 80C of the Income Tax Act. That said, even this will change under the Direct Taxes Code (DTC), which is expected to replace the Income-Tax Act from April 1, 2012. The SCSS scheme could then become less popular. Not only will the interest rates offered fluctuate from year to year and the interest be taxed but the deduction under Section 80C will also not be available.

Similarly, for the 5-year time deposits and the NSC, the 80C deduction will not be available under the DTC. Moreover, although interest on NSC is taxable every year, it is considered as a reinvestment and eligible for deduction currently. Once the DTC comes in, interest on NSC will also fall into the tax net.

All this is in addition to the reduction of the tenure of NSC from six years to five years, which could itself curtail the interest outgo. Assuming that the new 10-year NSC scheme will have the same product features as the existing one, its attractiveness remains to be seen as, historically, all these have become popular because of their tax benefits.

Fluctuating interest rates notwithstanding, the Public Provident Fund (PPF) appears to be attractive for those looking for long-term investment avenues.

Along with government PFs, recognised PFs and pension schemes administered by PFRDA, the PPF will continue to fall under the EEE method of taxation (i.e. no tax at the time of investing or on returns or the final proceeds) under the DTC, providing scope for overall returns to be higher.