As interest rates on savings accounts plummet, one can look at NPS Tier II and liquid funds of mutual funds to park idle cash and earn higher returns with easy liquidity.
After the country’s biggest lender, State Bank of India, reduced interest rate on savings deposits by 50 basis points for deposits below Rs 1 crore, most state-owned and private sector banks have followed suit. Banks are flush with funds after the surge in deposits post-demonetisation and continued slack in credit growth. Savings account balances accounted for 78% of the overall current account savings account (CASA) of banks and 30% of the overall deposit base as on June 30, 2017. These balances are sticky in nature as individuals use savings accounts for parking liquidity and not as an investment option. So, instead of parking surplus money in savings bank account one can look at National Pension System’s (NPS) Tier II account and liquid funds of mutual funds for higher returns and easy liquidity.
National Pension System Tier II
The NPS is an ideal investment option to build a retirement kitty. It has two options: Tier I and Tier II account.
While Tier I account is mandatory to save for retirement and avail tax benefits, Tier II account is like a debt mutual fund managed by seven pension fund houses. One can withdraw money whenever one wants without any limit and earn market-linked returns—combination of equity, government securities and corporate debt. But to open a Tier II account, one has to open a Tier I account first. The average one-year return in equity scheme of Tier II account is 17.5%, government securities 19% and corporate bonds 11%. Unlike Tier I account, there is no tax deduction benefit under Section 80C of the Income Tax Act for Tier II account and the returns from this account are added to one’s income and taxed as per slab. This is because NPS Tier II account does not have a locking period for funds, which is there in Tier 1 account. The redemption amount will vary depending upon the applicable NAV at the time of redemption and the money is transferred from trustee’s bank account to subscriber’s account in three working days.
Liquid funds of mutual funds
Liquid funds of mutual funds where money is invested in money market instruments like certificate of deposits, treasury bills, commercial paper and term deposits are an ideal option for individuals to park surplus money. The residual maturity of these funds is less than 91 days, these do not have any lock-in period and also allow instant redemption. These funds are mostly used by companies to park surplus money for short duration, ranging from a day to three months.
With Rs 3.23 lakh crore of assets under management as on July 31, 2017, liquid funds have reported annualised returns in the range of 6.5-7% over the last one year; the returns, however, have moderated to 6.25-6.5% over the last five months because of the fall in repo rate, according to a research note by credit rating agency ICRA.
Liquid funds are less volatile than equity funds because of shorter maturity profile of the underlying asset class.
As per Securities and Exchange Board of India’s norms, securities with maturity of less than 60 days are amortised on a straight basis to maturity from cost or last valuation price, which gives stability to the fund’s net asset value. Securities held for 61 to 91 days are valued on a mark-to-market basis, which has some market and credit risk.
Up to Rs 10,000 earned as interest from savings account is exempt from tax under Section 80TTA of Income Tax Act. However, sale of liquid funds units held for more than 36 months will attract long-term capital gains tax at 20% and sale before 36 months will attract short-term capital gains as per the individual’s tax slab. Experts say, even after paying the tax it still makes sense to park surplus money in liquid funds as the annualised post-tax returns of liquid funds are higher by over 200 basis points (See graphics on returns analysis) as compared with savings accounts.