The Public Provident Fund (PPF)
The Public Provident Fund (PPF) is a long-term savings instrument established by the Central Government. It offers tax benefits on contributions as well as withdrawals after the lock-in period. This scheme came into force on July 1, 1968, and is backed by the government with the objective of providing old-age income security to the self-employed and those working in the unorganized sector. Though the scheme is voluntary, assured returns and income-tax benefits have fuelled its popularity. The primary objective of saving in the PPF account is to avail tax deductions on deposits, guaranteed returns on investment, and tax-free withdrawal on maturity. Savings in this product are completely risk-free because of government backing.
Key Features of a PPF Account:
- Capital Protection & Inflation Protection
The capital in a PPF account is completely protected as the scheme is backed by the Government of India, making it fully risk-free with guaranteed returns. The PPF account is however not inflation protected, which means whenever inflation is above the latest guaranteed interest rate, the deposit earns no real returns. However, when the inflation rate is below the guaranteed rate, it does manage a positive real rate of return. For Example; If the Inflation rate is 7% and the PPF Interest rate is also 7%, then our Investment earns no real returns.
- Interest Rate
Interest rates are aligned with G-sec rates of similar maturity, with a spread of 0.25 percent. The government has decided to review the PPF rates quarterly. Interest on the PPF balance is calculated every month and the amount is credited to the PPF account at the end of every financial year. Each month, the interest amount is calculated on the lowest PPF balance in the account after the 5th of every month to the last day of the month. Hence, PPF investors are advised to make contributions to their PPF account before the 5th of each month. For the fourth quarter of FY 2020-21, the rate has been set at 7.1 percent compounded annually.
- Liquidity (Loan against investment)
The PPF is liquid, despite the 15-year lock-in stipulated with this account. Liquidity is offered in the form of loans against the PPF. However, the loan will only be granted if it is taken at any time from the beginning of 3rd year till the end of the 6th year from the date of activation of the account. The maximum loan amount is limited to 25% of the PPF balance at the end of the 2nd year or the year preceding the year in which the loan is being applied. You will have to repay the loan in 36 months.
- Investment tenure
A PPF account has a lock-in period of 15 years on investment, before which funds cannot be withdrawn completely. This tenure can be extended by 5 years at the end of the actual lock-in period. Premature withdrawals are allowed but only in case of emergencies subject to the condition that “after the sixth year, you can withdraw up to 50% of the balance at the end of the fourth year, or the immediately preceding year, whichever is lower”.
- Minimum and maximum investment
You must contribute at least Rs 500 and at most Rs 1.5 lakh in your PPF account in a year. The minimum investment of Rs 500 has to be maintained even for accounts extended beyond 15 years. If you don’t put in a minimum of Rs 500 a year, the account becomes dormant and Rs 50 penalty will be charged for reactivating a dormant account. If you put in more than Rs 1.5 lakh in a year, the excess amount, even if credited by mistake, will not earn any interest. The maximum limit of Rs 1.5 lakh per year includes the contribution in PPF accounts in the names of minor children.
- Tax Implications
The scheme has exempt-exempt-exempt (EEE) status, where the deposits, the interest earned as well as the maturity amount are tax-free. The sum invested in the PPF account is eligible for tax deduction under Section 80C subject to a maximum of Rs 1.5 lakh in a financial year. On maturity, the entire amount including the interest is tax-free.
- Additional tax benefits of PPF
Open a PPF account in the name of your spouse or child to gain additional tax benefits. As per tax laws, if money gifted to a spouse is invested, income from the investment is clubbed with that of the giver. Since PPF income is tax-free, it does not push up the tax liability of the giver. So one can invest up to Rs 1.5 lakh a year in this tax-free haven.