The Public Provident Fund (PPF) is a very good investment option that provides tax benefits, the interest earned as well as final maturity amount is tax free. However, many investors do not know how interest is calculated in PPF. Thus they tend to ask questions like when is the best time to invest, whether lump sum investment or monthly investment is more beneficial, etc.
The government on March 30, 2020 announced a steep cut in the interest rates on small savings schemes. PPF interest rate is now at 7.1%. The interest rate on small saving schemes and PPF are reviewed every quarter by the government. There is a Shyamala Gopinath committee which prepares the formula for calculating the interest rate on small saving schemes. The committee had suggested that the interest rates of different schemes should be 25-100 bps higher than the yields of the government bonds of similar maturity.
Interest rate calculations
Currently, interest on PPF balance is calculated on a monthly basis but it is credited to your account at the end of the financial year (March 31). Now let us go further and see how interest is calculated every month. The interest is calculated on the minimum balance in the PPF account between the fifth and the end of each month. So in a nutshell, if you invest after the 5th of that month, you will only get interest on the previous month’s balance but if you invest on or before the 5th of that month, then you will get interest on the current month’s balance apart from previous month’s balance.
A simple example will give us an idea of how a slight change in our payment schedule could provide us that extra advantage. We will take two scenarios—one where we invest before the 5th of the month and another where we invest after 5th of the month. Let us say we invest Rs 50,000 on August 3. The interest rate is 7.1% and our balance is Rs 3 lakh on July 31. Now, between August 5 and August 31, our minimum balance is Rs 3.5 lakh and our monthly interest would be (7.1%/12 X 3.5 lakh) = Rs 2,071.
In the second scenario, we deposit Rs 50,000 on August 6 and our balance as on July 31 is Rs 3 lakh. So our minimum balance between August 5 and August 31 is Rs 3 lakh so our monthly interest would be (7.1%/12 X 3.0 lakh) = Rs 1,775.
So as a PPF subscriber, if you wish to maximise your interest earnings, you should deposit your PPF contributions on or before the 5th of every month. The ideal option would be to invest Rs 1.5 lakh between April 1 and April 5 (total limit for investing in a year is Rs 1.5 lakh) at the start of the financial year. But many would not have the entire sum to invest in the beginning of the year, so they can deposit some amount regularly every month but they should try to deposit it by the 5th of that month to avail the maximum benefit as per the interest calculation method. The amount may be minuscule but why should we let go of interest on our hard-earned money. So next time when you are depositing money in PPF, try to deposit it by the 5th of that month.