Understanding the benefits of investing in National Savings Certificate

Introduction

The reliable National Savings Certificate (NSC) looks like it may have lost popularity with countless competing investment options available such as equities, mutual funds, unit linked insurance and fixed maturity plans. However, there is no ignoring the instrument's respectable returns, which are not only assured, but also tax-exempt (under section 80C) and government-guaranteed.

Compared with the NSC, the Public Provident Fund (PPF) has traditionally been more popular on account of its 8 per cent tax free interest. However, the PPF has a maximum investment limit of Rs 70,000 per annum which means the maximum amount one can invest in PPF every year is capped at Rs 70,000).

Investment limit

NSCs do not have a limit of how much you can invest. What's more, interest earned on NSC investments up to Rs 1 lakh is tax free. You read that correctly. NSCs offer you the possibility of earning up to Rs 1 lakh without paying tax whatsoever.

This is because NSC is the only small saving scheme wherein not only the initial deposit, but also the interest for the first five years, out of its term of six years, is eligible for a deduction under section 80C.

Interest and returns

NSC offers 8 per cent interest compounded half-yearly. Due to this compounding, the effective interest rate per annum works out to 8.16 per cent. It is a cumulative scheme with a term of six years, meaning, though the interest accrues every year, it is paid to the investor together with the initial capital invested at the end of six years.

For example, Rs 10,000 invested in NSC today will grow to Rs 16,010 at the end of six years compounded annually at effective interest rate of 8.16 per cent.

Let's talk about the tax treatment of the interest paid out. Unlike PPF, where the full amount of interest is tax free, NSC interest is taxable. However, as it is a cumulative scheme (for example, interest is not paid to the investor but instead accumulates in the account), each year's interest for the first 5 years is automatically re-invested in the NSC.

Since it is deemed re-invested, it qualifies for a fresh deduction under Sec 80C, thereby making it tax free.
Only the final year's interest, when the NSC matures, does not receive a tax deduction as it does not get reinvested, but is paid back to the investor along with the interest of the earlier years and the capital amount.

Illustration (All values indicating interest earned have been rounded off for simplicity:
Assume that you invested Rs 1,00,000 in an NSC on April 1, 2010. Interest on this investment for each year is shown in the following table: 

April 1, 2010: Initial investment = Rs 1,00,000.

March 31, 2011: Interest for the first year = Rs 8,160
Explanation: Rs 1,00,000 multiplied by 8.16 and then divided by 100).

March 31, 2012: Interest for the second year = Rs 8,830
Explanation: For the second year your principal will be Rs 1,00,000 + Rs 8,160 = Rs 1,08,160. This is because the interest of Rs 8,160 earned in the first year is added to your initial investment of Rs 1,00,000 and then interest (at 8.16 per cent) earned is calculated on Rs 1,08,160.

March 31, 2013: Interest for the third year = Rs 9,550
Explanation: For the third year your principal will be Rs 1,08,160 + Rs 8,830 = Rs 1,16,990. This is because the interest of Rs 8,830 earned in the second year is added to your corpus of Rs 1,08,160 and then interest (at 8.16 per cent) earned is calculated on Rs 1,16,990.

March 31, 2014: Interest for the fourth year = Rs 10,330
Explanation: For the fourth year your principal will be Rs 1,16,990 + Rs 9,550 = Rs . This is because the interest of Rs 9,550 earned in the third year is added to your corpus of Rs 1,16,990 and then interest (at 8.16 per cent) earned is calculated on Rs 1,26,540.

March 31, 2015: Interest for the fifth year = Rs 11,170
Explanation: For the fifth year your principal will be Rs 1,26,540 + Rs 10,330 = Rs 1,36,870. This is because the interest of Rs 10,330 earned in the fourth year is added to your corpus of Rs 1,26,540 and then interest (at 8.16 per cent) earned is calculated on Rs 1,36,870.

March 31, 2016: Interest for teh sixth year = Rs 12,070
Explanation: For the sixth year your principal will be Rs 1,36,870 + Rs 11,170 = Rs 1,48,040. This is because the interest of Rs 11,170 earned in the fifth year is added to your corpus of Rs 1,36,870 and then interest (at 8.16 per cent) earned is calculated on Rs 1,48,040).
Total interest earned in six years = Rs 60,110 (Rs 8,160 + Rs 8,830 + Rs 9,550 + Rs 10,330 + Rs 11,170 + Rs 12,070)

Total value of investment at the end of sixth year which will be taxed = Rs 1,60,110 (Rs 1,00,000 + Rs 60,110. 

What you must ensure while filing tax return

To benefit from this feature of re-invested interest and its deduction, it is important to declare the accrued interest on NSC on a yearly basis in your tax return.

In the above example, for financial year 2010-11 (the current financial year), you will include the interest amount of Rs 8,160 in your tax return under the head 'Income from other sources'. Under deductions, you will claim Rs 8,160 under Section 80C as re-invested NSC interest. Both cancel each other out, making the interest in effect tax free.
From the above discussion, it is shown that both NSC and PPF interest is tax free. However, the difference is that PPF interest is tax free per se, whereas the NSC interest becomes tax free on account of the deemed reinvestment under Section 80C.

Remember that Section 80C has a maximum limit of Rs 1 lakh.

Your NSC interest would only qualify for the deduction provided you have funds left in Section 80C. Provident fund contributions, insurance premiums, housing loan principal repayments, tuition fees, PPF, tax saving mutual funds and bank deposits -- not to mention any fresh investment in NSC -- are also covered under the same Rs 1 lakh limit. So, if you want to invest and take advantage of the tax-saving feature of NSC interest, remember to make the adjustment so far as the other tax-saving investments are concerned.
   
Where and how to buy?

National Savings Certificates (NSC) are issued by Department of Post, Government of India, and are available at most post offices in the country in denominations of Rs 100, Rs 500, Rs 1,000, Rs 5,000 and Rs 10,000. NSCs can also be transferred from one person to another by paying a small fee. They can also be transferred from one post office to another.

Life Begin's After 50

If you fall under this category, go for a conservative asset mix & adequate cover while securing your finances.

In today’s world, it’s a Herculean task to fulfil all your family responsibilities. It takes all your savings and emotions to make sure that your kids find their feet in today’s highly competitive world. And when these fledglings finally spread their wings and move on, you find yourself emotionally and sometimes monetarily drained. Take the case of 51-year-old K D Sharma. Within a few months of their daughter’s wedding, their son also decided to move out. The couple suddenly realised that now they are financially strained. Their life-long savings been utilised for securing the future of their kids and it appeared that they have to start afresh. So, if you are also undergoing through the same pangs, here are some tips that can help you chart out a new chapter after you’re done with all your responsibilities. 

Asset Mix 

Considering that most empty nesters belong to 50+ age category, financial planners recommend a conservative asset allocation, which could comprise of up to 30% allocation to equities. While current income generating securities such as small savings schemes, fixed maturity plans, and long term bank fixed deposits can form 50% of the asset mix. The remaining investment (20%) should be made in fixed income securities with low maturity such as short-term income funds, liquid funds and short-term bank fixed deposits with an objective of maintaining liquidity for contingencies. The main priority for empty nesters is to preserve existing wealth and plan for retirement. Hence such a mix would generate growth with added stability apart from current income.

However, analysts caution that it may not be appropriate to implement the same asset allocation across investors as conditions differ significantly across empty nesters. For the uninitiated, asset allocation for any investor is determined based on the investor’s age, socio-economic background, lifestyle, risk appetite, liquidity requirements and finally the investment horizon. 

On the equity market investments, financial planners believe that the exposure should be restricted to a complementary blend of three to five quality diversified equity funds with low risk. And they should avoid the temptation of sector/thematic funds or/and a direct exposure to equities by purchasing individual securities. The investor should view equity exposure as a long-term asset class in the portfolio and hence a systematic investment plan could be the ideal strategy for investing in equities.
 

Financial planners also advise such families to set aside at least three months household expenses as contingency fund, which ideally should be risk-free and can be easily liquidated. It is pertinent to calculate amount needed to meet living expenses for remaining life, amount needed for charity or passing on to the family members. You should not wait till the end for such decisions. 

Adequate Cover
 

Insurance advisors suggest protection against early death, disability and medical coverage as important insurance covers an empty nester must have. Normally being on the other side of 50’s, the insurance premia for such insurers is very high. Some unit linked insurance policies offered by private sector insurance companies provide both medical and life insurance coverage, which empty nesters could look to take cover under.
 

Since being on their own, empty nesters have significant amount of extra time and cash to pursue long cherished interests and hobbies or some new activities. So while pursuing these interests, it is advisable that they should fine tune the financial plans to accommodate the new lifestyle. The biggest mistake people make after the kids leave the house is not reviewing the insurance policies. What they forget is that it’s one of the key times to look at insurance and plan accordingly.
 

According to Aggarwal, a whole-life Ulip will be the ideal cover for such category of people. Choose a product with lesser premium paying commitment of maximum 5-10 years and coverage for whole life with asset allocation of 50% in Debt and 50% in Equity. You can also use these policies for tax-free retirement planning since such a product gives you the flexibility of liquidity every year. They also advise a second look at your health insurance. It is important that you should have enough coverage as it may become difficult to take larger cover after certain age.

It’s Never Too Late

A conservative asset allocation, comprising up to 30% equities, is recommended Current income generating securities such as small savings schemes, fixed maturity plans and long-term bank fixed deposits can be 50% of the asset mix Around 20% can be put in fixed income securities with low maturity such as shortterm income funds, liquid funds and shortterm bank fixed deposits Choose an insurance product with lesser premium paying commitment of maximum 5-10 years and coverage for whole life

Balancing act - How much liquid cash to have in hand is an aspect of portfolio management an investor needs to master

If the initial public offers (IPOs) in the market tempt you, and the new fund offers (NFOs) arouse your interest, then there is quite a possibility that you are frantically going through your savings account, little realizing that this could eventually lead to a situation where you are neck-deep into investments with little or no cash at hand.

With the market scaling new heights almost every passing day, there are a number of investors who are looking for immediate returns from the bourses. They often forget that investment is only one part of managing personal wealth.

Financial planners recommend that greater emphasis should be on how to make existing investments work. And it’s important that you should have enough liquidity in your portfolio, if any need arises. So, if you’ve been wondering how to stay in the bull run and still have enough cash at hand, here is an insight on the balancing act for a comprehensive portfolio.

Analysts believe that with rise in consumerism and parallel growth in retail banking and consumer finance, the need for cash at hand or contingency fund has vastly diminished. Credit cards have emerged as the most convenient way of funding short-term spending needs without panic liquidation of portfolio. Overdraft facilities and personal loans against assets, property or securities are generally easy to raise, are quick and require minimal paperwork. In other words, keeping liquid cash sloshing around in your current or savings bank account is not the recommended option.

However, this doesn’t mean that you totally discard the option of having any cash-in-hand. “The amount of cash to be kept depends on several factors, though one thumb rules says that at least ‘three months expenses’ should be kept in your bank balance,” says Manoj Vaish, president & CEO, Dun & Bradstreet India. He cautions that in no case financing from credit card should be used, as the charge could be as high as 24 to 36% per annum.

Cash-in-hand may be advisable if you have recently booked profits. “The market is too volatile to make fresh investments and a correction is imminent. Cash-in-hand is also necessary if you have taken forward buying or selling positions, just in case the market does not move as predicted,” he affirms.

Analysts feel that for a salaried person who has a regular and predictable source of income, the cash balance should be just enough to meet one-two months of household expenses. This, of course, has to be backed up by a few credit cards, fixed deposits of 6-12 months maturity (preferably in multiple units so that, if the need arises, you need not break the whole fixed deposit) and other liquid investments such as open-ended mutual funds. This is, in case, you need funds urgently for personal reasons or also to capitulate on any fresh investment option.

Though how much cash one should keep depends on an investor profile, Vaish insists and adds that the guiding principles remain the same. You should take into account — any upcoming expenditure (travel & holidays, school fees, tax payment), steadiness of income (stable like salary or variable as in business), how quickly other investments can be converted into cash (financial assets are much easier than real assets), medical insurance cover and the ability to quickly arrange a personal loan to meet any unforeseen contingency.

Investment in shares is desirable though the extent to which it should be in your portfolio depends on the age and risk profile. It is almost impossible to time the market. Steady investment spread over a period of time such as through Systematic Investment Plans (SIP) and with a long term investment horizon (5 to 15 years) is best suited for this purpose.

With so many options available, cash as a portion of your portfolio may not be as necessary in today’s times, as it was earlier. However, it’s pertinent that for a balanced portfolio, you need to re-work your maths before investing in the spur.

How to make bank fixed deposits work for you

It's that time of the year when most of us would be receiving salary hikes and bonuses. While few of us would have already planned for things to buy or invest into, a majority would still be unclear about what to do with their money. For the latter, the money would lay idle in their banks' savings account by default.

Though it will earn an interest of 3.5 per cent per annum, we think you deserve to earn more. Don't you?
So instead of keeping it in the savings account, there are many schemes / facilities offered by banks that can come handy during these times. For example normal bank fixed deposits schemes, flexible rate deposit schemes, and sweep-in / sweep-out facility.

Each of these options provide for higher interest rates compared to bank savings account and with the same degree of safety. Let's look at these options and choose the right mix so that your money starts earning more money for you.

Everyone knows about bank fixed deposit (FD) schemes. The tenure of deposit ranges from 7 days to 10 years. However, the suggestion here is not to go for FD of less than 3 months. This is because the rate of interest on such deposits is less than what is offered by savings account (3.5 per cent).

Please note that as per the Reserve Bank of India's, RBIs, new guideline, the rate of interest on savings account will be calculated on a daily basis.

So, if you want high liquidity for 3 to 4 months, then do not use the FD route. Your savings account will fetch you 3.5 per cent interest anyways.

The best way to invest in a FD is to book multiple FDs with varying maturities. If you need certain amount of money after 1 year, go for 1 year FD for that much amount. Depending on the future money requirements, other FDs with higher maturity of say 3 years, 5 years or 7 years can been booked accordingly.

By applying this simple strategy, you are meeting your liquidity requirements as well as earning higher return on a cumulative basis. And not to forget, you are not breaking any FDs to meet your requirements.

Words of caution: At the time of booking any FD, make sure you are selecting the correct interest payout option. If you want regular returns, go for quarterly or half-yearly payout options. Else, choose interest re-investment option (your interest payout will be re-invested to earn more money for you).

Another advantage of investing in fixed deposits with tenure of 5 years or more is that you can avail tax rebate on your annual salary for the current financial year. As per Section 80C of the Income Tax Act, you are eligible to get tax rebate on an investment of up to Rs 1 lakh in bank FDs of 5 year or more.

The Flexible Rate Deposit Scheme collects money from investors and invests in government bonds of various maturities. Since government bonds are traded in the market, the rate of interest is determined by the economies of demand and supply.

Here too, you can select various products with different maturities and earn variable rates of interest. This way you can build a portfolio of flexible FDs that will match your returns with what is prevailing in the market.

The objective of the scheme is to provide protection against interest rate volatility by offering deposits at flexible interest rates. Flexible rate schemes are a win-win product for both the depositor and the bank since the rates are directly linked to the market.

Another advantage of this scheme is that it acts as a hedge against inflation. Ideally, if inflation rises, your real return (actual return minus inflation) from normal FD declines. However, in case of flexible rate deposit scheme, the real return would remain unchanged. This is because RBI will raise interest rate to tackle inflation, which in turn will raise market interest rate, and hence your return from flexible FD will increase proportionate to inflation.

Many banks are nowadays offering such facilities. The Sweep-in / Sweep-out facility provides the benefits of both worlds -- the liquidity of savings account and the higher returns of FD.

This is how it works: Whenever your savings account balance crosses the average quarterly balance requirement, the excess amount gets automatically swept into a flexible fixed deposit. Thus earning you a higher return vis-a-vis bank savings account.

The best part is that your FD is not fixed. In case you want to withdraw more than the available average balance, the fixed deposit will be broken to the extent of the amount you require to meet your needs. Thus giving you the liquidity of a savings account.

This is basically good for those who are not sure about their liquidity needs in the short-medium term.

Summary

By choosing a judicious mix of bank products discussed above, you can make your money work for itself. After all you have earned your annual bonus through sheer hard work and pain! But bank FDs are just one of the options for you.

You should look to exploit other options like stocks, mutual funds, real estate, etc. Here we have just provided guidance on how to leverage banks' existing products to generate higher returns vis-a-vis bank savings account. The idea finally is to make you a smart wealth manager of your own money.