PPF Interest Rate: 11.48% effective yield on investing upto Rs 1.5 lakh for these taxpayers!

PPF Interest Rate: 11.48% effective yield on investing upto Rs 1.5 lakh for these taxpayers!

 

PPF Effective Interest Rate:

The interest rate on the Public Provident Fund (PPF) for the quarter ending December 2019 has remained unchanged at 7.9 per cent. If you think that it is too low an interest rate, then you need to look at the effective interest rate or the effective yield. At times, one may have to decide whether 8 per cent bank FD is better than investing in PPF?

Comparing the interest rate on a taxable investment with that of a tax-free investment is not the right way as one needs to look at the pre-tax yield of both of them.

For the bank FD or any other taxable investment, the pre-tax yield is its coupon rate of interest. But, as the interest income in PPF is tax-free, the effective rate of return for taxpayers is higher based on the individual tax rate. For someone in the highest tax slab paying 31.2 per cent tax, the effective yield is nearly 11.48 per cent. It is also referred to as the pre-tax yield, which means the return on an investment before any tax is applied on the returns.

Taxpayers need to pay a tax of either 5 per cent, 20 per cent or 30 per cent based on their income level. In addition, there is a surcharge of 4 per cent on the tax liability calculated on total income. So effectively, the tax rates are 5.2 per cent, 20.8 per cent and 31.2 per cent for the taxpayers.

The formula for calculating the PPF effective interest rate is :

Pre-tax yield = Interest Rate / (100-TR) * 100

(Using excel sheet, the formula can be put to use)

Here, the interest rate for PPF is 7.9 per cent while TR is Tax Rate.

31.2 per cent, the Pre-tax yield of PPF will be
= 7.9 / (100-31.2)*100 = 11.48 per cent.

Therefore, for someone having a tax rate of 31.2 per cent, the Pre-tax yield of PPF will be
= 7.9 / (100-31.2)*100 = 11.48 per cent.

20.8 per cent, the Pre-tax yield of PPF will be
= 7.9 / (100-20.8)*100 = 9.97 per cent.

For someone having a tax rate of 20.8 per cent, the Pre-tax yield of PPF will be
= 7.9 / (100-20.8)*100 = 9.97 per cent.

5.2 per cent, the Pre-tax yield of PPF will be
= 7.9 / (100-5.2)*100 = 8.33 per cent.

And, for someone having a tax rate of 5.2 per cent, the Pre-tax yield of PPF will be
= 7.9 / (100-5.2)*100 = 8.33 per cent.

What it means Your PPF account will fetch an interest rate what the government declares at the start of each quarter of the financial year. Illustratively, on an investment of Rs 1.5 lakh, at 7.9 per cent, the interest income will be Rs 11,850. The effective or pre-tax yield is only for illustrative purposes to help one decide between choosing a taxable investment or a tax-free investment.

For example, if someone paying 31.2 per cent tax finds an investment fetching interest rate higher than 11.48 per cent, putting money in it will sound better. In reality, taxable investments such as bank fixed deposit, bonds or debentures are fetching lower rates around 7.5 per cent. Further, if there are any taxable investments providing higher returns, there will be risks attached to it too.

As the effective yield for those in the 5 per cent, 20 per cent or 30 per cent tax slab is 11.48 per cent, 9.97 per cent and 8.33 per cent respectively, PPF can be one of their preferred investment.

PPF remains a time-tested investment avenue over several decades backed with a sovereign guarantee and comes with tax benefits such as tax-free return and investment being deductible under section 80 C of the Income Tax Act,1961.

Happy Investing

Source:Moneycontrol.com