PPF Trick: The sovereign guarantee that PPF enjoys on both the principal invested and interest earned is the clincher while the interest income also remains tax free.
PPF Investment : Public Provident Fund (PPF) is one of the few investment options that has stood the test of time over several decades. The sovereign guarantee that it enjoys on both the principal invested and interest earned is the clincher while the interest income also remains tax free. On top of it, there is income tax benefit under section 80C on the amount invested in PPF. Therefore, PPF enjoys E-E-E- status as it comes with tax exemption at investment stage, growth remains tax-exempt and even maturity remains tax-free. One other important feature of PPF remains largely ignored – Compounding of interest that happens annually in PPF. PPF being a long term scheme of 15 years, the impact of compounding is the best in PPF.
The minimum and maximum annual investment in PPF is Rs 500 and Rs 1.5 lakh and PPF contributions need to be made each year for 15 years to keep the PPF account active. By investing a minimum of Rs 500 during one financial year, one can keep the PPF account active. The interest is on the outstanding balance in the PPF account. Let us see the effect of compounding, if contribution in the last 5 years of PPF is kept only at Rs 500.
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Impact of compounding on PPF
An example: The interest rate of PPF is assumed to be 8 per cent per annum throughout the 15-year period.
On investing Rs 1.5 lakh each year, the maturity value comes to about Rs 43,50,547 – where Rs 22.5 lakh is the principal invested and nearly Rs 21,00,547 lakh is the interest earned, that makes 48.28 per cent as the interest amount!
Now, let us suppose one invest Rs 1.5 lakh each year only for the initial 10 years and then invest only Rs 500 for the last 5 years to keep the PPF account active. The maturity value comes to about Rs 34.5 lakh, of which 56 per cent is the interest!
The amount of interest earned in the last five years is nearly Rs 11 lakh on a total additional contribution of Rs 2,500. This is possible because of the effect of compounding as interest declared earns interest on each year’s balance amount.
The above is just an example to show how compounding works in PPF. Ideally, one should maximise the contributions and if investible surplus is not available at the beginning of the financial year, try to make PPF deposits before 5th of each month. The PPF rules allows one to extend the PPF account indefinitely in a block of 5 years, with or without making fresh contributions. The longer you run your PPF account, more will be the impact of compounding to reap its benefits during your retirement.