Small savings schemes: Pay heed to return, taxation, and lock-in

Returns of some schemes remain unchanged throughout the tenure, but can fluctuate in the case of others

The financial year ended on a happy note for fixed-income investors, with the government raising interest rates on small saving schemes (SSS) such as National Savings Certificate (NSC), Sukanya Samriddhi Yojana (SSY), Senior Citizens Saving Scheme (SCSS) and post-office term deposits. The return offered by the Public Provident Fund (PPF), however, remained unchanged. Do the hikes make SSS attractive, especially at a time when debt funds have lost the indexation benefit on long-term capital gains?

“Small savings schemes have certainly become more attractive after the recent hikes in interest rates. They look even more attractive now that debt mutual funds no longer enjoy indexation benefit,” says Amol Joshi, founder, PlanRupee Investment Managers.

Risk-free but illiquid

Many conservative retail investors depend on SSS. “Most SSS now offer returns that beat inflation. They are very safe as they enjoy sovereign backing. Conservative investors looking to allocate to fixed-income products may consider these schemes,” says Parul Maheshwari, certified financial planner.

However, these schemes don’t score high on liquidity. The ones that offer the highest returns, such as PPF, SSY, etc in particular come with long lock-ins.

Lock-in interest rates

Some of these products pay the same rate of interest—the one that prevailed at the time of buying the instrument—throughout their tenures. These include the NSC, postal time deposits, and SCSS. Even if the government changes the rate of interest on these products, investors continue to get the same return as earlier. Such products can help investors lock in the rate of return until maturity and remain unaffected in a declining rate environment.

The returns offered by products such as PPF and SSY change as and when the government reviews them. However, the big upside of these products is that the corpus they pay out on maturity is tax free. This makes them suitable for long-term goals such as retirement and child’s education.

Some of the factors investors must take into consideration when selecting a SSS include their cash flow needs and the tax bracket to which they belong.

“Parents with girl children can benefit by allocating to SSY. PPF with its EEE (exempt-exempt-exempt) status remains as attractive as ever,” says Joshi.

Adds Maheswari: “Investors belonging to the higher tax brackets should consider PPF, which offers 7.1 per cent interest tax-free, making it one of the best instruments.”

Avoid debt funds?

Although debt funds have lost the indexation benefit from April 1, 2023, and are now on a par with fixed deposits and SSS on the taxation front, they offer a few advantages. These include diversification, market-linked returns, interim liquidity, and an opportunity to benefit from falling interest rates. They also allow investors to defer their tax liability.

“Debt mutual funds offer high liquidity. It is also very simple to hold them through the digital or demat route. And you can easily see their day-to-day valuations by checking the net asset value (NAV),” says Santosh Joseph, CEO and founder, Refolio Investments.

Investors in high-income tax slabs looking for long-term compounding can still consider debt funds.

How to invest in SSS?

Investors should first determine their financial goals and then arrive at an appropriate asset allocation to achieve them. They should then select the appropriate SSS for the fixed-income allocation in these portfolios.

PPF and SSY can help fund long-term goals. Mahila Samman Savings Certificate and postal time deposits, on the other hand, are better suited for short-term goals. SCSS is for senior citizens who require regular cash flows.

“Don’t buy an SSS just because the yield is good or because debt funds are now taxed at a higher rate. Instead, identify your investment needs and then select a product if it suits you,” says Joseph.

While the assured returns provided by SSS offer peace of mind, don’t put all your eggs in these schemes alone. “Young investors and those with some appetite for risk should also consider equity mutual funds as they have the potential to deliver higher returns than fixed income over the long term,” says Maheshwari.