Skip to main content

PPF taxation: Why the Public Provident Fund is a safe option to save tax; 5 things to know

When it comes to tax saving many often turn to the Public Provident Fund (PPF). This is because of two key factors: the tax-free yearly interest and the annual compounding effect. The extended tenure of 15 years for PPF plays a significant role in amplifying the impact of compounding, particularly in the later stages of the investment period. Further, because the interest earned is backed by a sovereign guarantee, it makes it a safe investment option.

 

It's essential to be aware that starting from the financial year 2020-21, individuals have the choice to opt for the old/existing tax regime, which includes various deductions and exemptions like those under sections 80C, 80D, 24, and more. Alternatively, they can opt for the new tax regime, which excludes these deductions and exemptions. If an individual chooses the new tax regime in the current financial year, they won't be eligible to claim commonly availed benefits such as deductions for investments in PPF, among others. So, if you select the old or existing tax regime, here is how investing in PPF can help you save tax under section 80C of the Income-tax Act, 1961.

 

Returns from PPF

The interest rates of small savings schemes are linked to yields of the 10-year Government Securities (G-Secs) in the secondary market. There are set formulae for mark-ups over the previous three months' average yield of relevant G-Secs of comparable maturity. The central government reviews the interest rates of small savings schemes every quarter based on the G-Secs yields of the previous three months. This is in line with the recommendations of the Shyamala Gopinath Committee, 2011 to ensure that the interest rates of small savings schemes are market-linked.

 

The current interest rate for January to March 2024 is 7.1 per cent per annum. While the minimum annual amount required to keep the account active is Rs 500, the maximum amount that can be deposited in a financial year is Rs 1.5 lakh.

 

How is PPF taxed?

PPF is among the select few investment products that benefit from the triple tax exemption, often known as the exempt-exempt-exempt (EEE) classification. This means that tax exemptions are granted at the time of investment, accrual, and withdrawal.

 

Under section 80C of the Income-tax Act, 1961, investments made during each financial year are eligible for a deduction of up to Rs 1.5 lakh. Tax exemption also applies to interest generated annually. Thirdly, you receive tax-free income when you remove the accumulated corpus upon maturity because it is likewise free from taxes.

 

How compounding works in PPF

By investing the maximum allowed amount of Rs 1.5 lakh annually for 15 years in PPF, and assuming an average interest rate of 7.6 percent, the accumulated corpus reaches approximately Rs 42.5 lakh. PPF demonstrates the effectiveness of compounding, particularly over an extended duration. This underscores the importance of allocating the maximum feasible amount in the initial years, allowing sufficient time for the funds to compound and grow.

Let's say someone invests Rs 1 lakh annually for 15 years, then the corpus adds up to almost Rs 28.5 lakh, at an average interest rate of 7.6 percent per annum. Of the corpus, the interest amounts to about Rs 13.5 lakh, nearly 47 percent.

 

Now, let's say, Rs 1 lakh was invested only for the first 10 years (minimum of Rs 500 put in to keep account active) and the funds were left to grow till the end of the 15th year. The corpus will be nearly Rs 22 lakh, the interest portion amount to nearly 55 percent. Even without fresh contributions, the interest gets added each year on the previous year's balance and thus compounding takes place.

 

On maturity of PPF

There is no obligation to close your PPF account upon the completion of 15 years from the end of the year in which the initial subscription was initiated. It can be extended indefinitely in blocks of 5 years, with the option to continue or discontinue making fresh contributions. During the extended period, individuals are permitted to make partial withdrawals once a year, offering flexibility to meet regular income needs.
Labels:

Comments

Post a Comment

Popular posts from this blog

Banking Norms

 What is IFSC ? IFSC stands for Indian Financial System Code. It is a 11-digit alpha-numeric code that uniquely identifies a bank branch participating in any RBI regulated funds transfer system. The IFSC code helps to transfer money using RTGS, NEFT or IMPS method. The first 4 digits of the IFSC represent the bank and last 6 characters represent the branch. The 5th character is zero.   What is MICR ? MICR is an acronym for Magnetic Ink Character Recognition which is a technology used in the banking industry in printing the MICR codes. A MICR code is a 9-digit code that uniquely identifies a bank and a branch participating in an Electronic Clearing System (ECS). The first 3 digit of the code represents the city code, the middle ones represent the bank code and last 3 represents the branch code. One can locate the MICR code at the bottom of a cheque leaf, next to the cheque number. It is also normally printed on the first page of a bank savings account passbook.   What is t...
Post a Comment
Read more

What The 50/30/20 Budgeting Rule Means

The 50/30/20 budgeting rule is one of the best known ways to start a solid money management journey. It does not matter how much you earn. You can easily apply this rule and develop the much-needed financial discipline. Here’s how you can begin: First, write down your total earnings. Be it from your full-time jobs, any freelancing gigs, or short-term projects, include them all.  Then, segregate this amount into three buckets of 50, 30, and 20.   50% CONSTITUTES YOUR NEEDS You can fund all essential payments via this chunk. You should pay your rent, electricity, and other utility bills. These are imperative expenses intrinsic to your survival. Hence, they cannot be delayed at any cost.  In addition, you should also pay off all your loan installments, the minimum amount (at least) due on credit cards, and insurance premiums with this segment. Solidifying your financial health is important and, in fact, non-negotiable.  Hence, make sure you put aside enough money at the...
Post a Comment
Read more

What is KYC - Meaning, Types, and Importance

Since 2004, the Reserve Bank of India made it compulsory for all Indian financial institutions to verify both the identity and address of all customers carrying out financial transactions with them. Thus, the KYC process was introduced by the RBI as the only mode of verification.   What is KYC? KYC means to ‘know your customer’ which is an effective way for an institution to confirm and thereby verify the authenticity of a customer. For this, the customer is required to submit all KYC documentation before investing in various instruments. All financial institutions are mandated by the RBI to do the KYC process for all customers before giving them the right to carry out any financial transactions. Whether the customer uses KYC online verification or opts for offline KYC, this is a simple one-time process.   The significance of KYC KYC is an important tool as it looks after the financial bodies and keeps illegal activities in check. Many non-individual customers use financial se...
Post a Comment
Read more