Prudent provident fund

Evaluating past favourites for present day investors. The safest bet for the risk-averse investor, which offers guaranteed returns with liquidity.

By Narayan Krishnamurthy | Print Edition: January 25, 2007

The ubiquitous Public Provident Fund or PPF, as it is more popularly known, occupies a prominent place in most portfolios. It was established in 1968 as a savings option for non-salaried persons. The idea was to give people in the unorganised sector access to the same benefits as salaried employees who are covered by Employees PF and Government PF.



 Public Provident Fund (PPF)


 No bar on entry and exit age


 15 years, can be extended
further in 5-year blocks

 Minimum Contribution

 Rs 500 a year

 Maximum Contribution

 Rs 70,000 a year

 Open to

 Individuals, HUF

 Tax Benefit

 Investments up to Rs 70,000;
a year exempt from tax;
income from withdrawal tax free

There has been a sea-change in the investment scenario since 1968. But PPF remains a popular and hence, politically sensitive investment. The USP is the combination of a high-mandated interest rate and attractive tax breaks. Moreover the minimum entry level is very low and it offers flexibility and liquidity within strictly defined boundaries.

Any resident individual can subscribe to PPF—even one who is salaried and subscribing to other PFs. It can even be subscribed to by a guardian on behalf of her ward or by a Hindu Undivided Family. Individuals can also subscribe on behalf of associations. Non-resident Indians aren’t eligible to open PPF accounts.

All branches of the State Bank of India and several other nationalised bank offers PPF accounts. A PPF account can also be opened at a post office. The subscriber is given a passbook where the details of subscriptions, interest accrued, withdrawals, loans and repayment and the like are recorded.

 Investment Blues—The risk factors

 - PPF offers guaranteed returns to the investor notified by the Central Government in the official gazette
- The scheme has seen a shortfall between the government's returns from PPF funds and the returns that it promises to pay
- The PPF collections are not professionally invested. Part of the annual collections is used to meet corresponding withdrawals
- It's a Ponzi Scheme and the shortfall in PPF earnings make it unsustainable in the long run and a risky instrument
- 100% of the net annual collections are distributed among the state governments at 9.5% interest
- PPF interest is calculated for calendar month and is credited at the end of each financial year

In a financial year, PPF accepts a minimum contribution of Rs 500 and a maximum of Rs 70,000. A single contribution may be any multiple of Rs 5 and a maximum of 12 installments per year are allowed. Contributions in excess of the stipulated Rs 70,000 carry neither tax rebate nor interest. And, the guaranteed rate is reviewed annually.

The account has a 15-year term with a provision to continue for block periods of five years. In case of an account extension, the option has to be exercised inside the 16th year. If an individual does not withdraw the funds or formally extend the account, the investment will continue to earn interest but tax benefits under Section 80C are withdrawn.

The tax benefits are the most compelling reason to opt for PPF. Contributors to PPF are eligible for deduction for every income tax assessee. The interest is tax free and, at the time of withdrawal, the entire amount is tax-free.

Assume you’re in the top income bracket. You contribute Rs 70,000 per annum for 15 years at (current) 8%. Each year you save about Rs 23,000 in tax outflows. After 15 years, you have a tax-free nest egg of Rs 25.97 lakh.

In 1968, it offered a paltry 3.5%. In the mid-1990s, that rate rose to a high of 12% and it’s now down again to about 8% net of tax (where a oneyear bank FD will fetch you 6.5% pre-tax). Since 2001, it has on average, offered a premium of 1-1.5% on bank FD rates and, once we factor in the tax exempt status, that is indeed, quite generous.

There is a minimum lock-in period of five years after which, the PPF allows one withdrawal a year. The maximum amount that can be withdrawn is 25% of the amount that accrued at the end of the fourth year. For instance, if you’ve made the maximum contribution, by the end of the fourth year, your deposit will be about Rs 3.4 lakh. You may withdraw up to one fourth of it which roughly works to Rs 82,760.

And at the expiry of 15 years from the end of the year in which the initial subscription was made, an account may be closed through the withdrawal of the entire balance. If you wish to continue after the 15-year tenure, you can make a partial withdrawal every year, subject to the condition that the total withdrawals in five years shall be a maximum of 60% of the credit balance at the commencement of the period.

There is also a provision to avail loans under PPF. After the expiry of one year from the end of the financial year in which the initial subscription was made but before the expiry of five years, a loan may be obtained. Thus technically the first loan can be taken in the third financial year from the fiscal in which the account was opened. The loan repayment can be done either in lump sum or installments within 3 years from the date of taking the loan. After full repayment of the principal, the subscriber must pay interest at 1% per annum on the principal. The interest rate is hiked to 6% per annum if the loan is unpaid for three years.

There is another way to derive maximum benefit from this instrument: in case you have been investing in PPF for three-four years and feel the returns are not as exciting as an ELSS, don’t lose heart; there is room to cushion your loss. From the seventh year you can make partial withdrawals from your PPF, and this is tax free. So, all you need to do to maintain the 15-year period and get the maximum out of the PPF is to recycle your PPF withdrawal from year seven. The withdrawal is not treated as income and when it goes back to the PPF account to maintain the 15-year tenure, you get tax rebate on the contribution as well.

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