If you belong to the same
generation as me (born in mid-late 80s), then chances are that you would have heard
about NSCs, but would not have invested in them. But if you are of a generation
prior to me, then chances are high that some of your money might be invested in
this instrument.

But there is another problem with NSCs. These instruments have a lock-in of 5 years and 10 years. Now this is an extremely long period for our impatient generation. But there is a way in which this lock-in can be managed in a way that an investor receives some money at the end of every year. The approach which I'll discuss increases the liquidity of NSCs, with a little help from Fixed Deposits. This approach reduces the return a little. But that is a price we need to pay for increased liquidity. :-)

NSC stands for

*National Savings Certificates*. These are reliable, tax efficient (tax exempt under section 80C) and guaranteed by the govt. You can read more about it**here**.National Savings Certificate |

So why is it that my generation is neglecting
this instrument?

The main reason behind this is instrument's
so called 'lower returns'. Lower when compared to more glamorous returns
claimed by riskier ones like equities, mutual funds and ULIPs. Returns offered by NSC are between 8.5% and 8.8% depending on the flavour (5 year or 10 year)
you chose. But since interest is calculated six monthly, the effective rate
ranges between 8.78% and 9.00%. And that is not all. Investment in NSC can be claimed as a deduction under Section 80C. Also, the interest income is tax-exempted. So returns are much higher than what it seems at
first glance. And these are assured returns with almost no risk, unless the
govt. decides to default. :-)

But there is another problem with NSCs. These instruments have a lock-in of 5 years and 10 years. Now this is an extremely long period for our impatient generation. But there is a way in which this lock-in can be managed in a way that an investor receives some money at the end of every year. The approach which I'll discuss increases the liquidity of NSCs, with a little help from Fixed Deposits. This approach reduces the return a little. But that is a price we need to pay for increased liquidity. :-)

I'll refer to this approach as
the

**NSC-LADDER**. We use NSCs and Bank Fixed Deposits (for initial period of the strategy) in this approach. So here it goes...
Suppose at the start of time
(Year 0), you have Rupees One Lac (Rs 1,00,000) to invest. Though you are
ready to invest for long term, you are not very comfortable with the lock-in of
5 years (or 10 years) and want to invest (safely) in some (reliable)
instruments which have some amount of liquidity. The interest rates on NSC & FDs of different tenures is as follows -

You start by dividing this
one lac into five parts of Rs 20,000 each. You invest first in a bank FD with
maturity period of One Year. Invest the second in a FD of 2 Years, third
for 3 years, fourth for 4 years and finally fifth for 5 years.

After this, what happens is
that you receive maturity amounts from respective FDs at the end of first,
second, third, fourth and fifth year. The maturity proceeds are in turn
invested in 5 year NSCs starting from start of Year 2, 3, 4, 5 and 6.

This is what exactly happens -

NSC Ladder : Click to enlarge |

This is what exactly happens -

- 1st Tranche: Invested Rs 20,000 in FD for One Year - Received Rs 21,600 at end of Year 1 - This sum is invested in NSC for 5 Years - Received Rs 32,750 at end of Year 6.

- 2nd Tranche: Invested Rs 20,000 in FD for Two Years - Received Rs 23,545 at end of Year 2 - This sum is invested in NSC for 5 Years - Received Rs 35,699 at end of Year 7.

- 3rd Tranche: Invested Rs 20,000 in FD for Three Years - Received Rs 25,901 at end of Year 3 - This sum is invested in NSC for 5 Years - Received Rs 39,271 at end of Year 8.

- 4th Tranche: Invested Rs 20,000 in FD for Four Years - Received Rs 28,232 at end of Year 4 - This sum is invested in NSC for 5 Years - Received Rs 42,805 at end of Year 9.

- 5th Tranche: Invested Rs 20,000 in FD for Five Years - Received Rs 30,073 at end of Year 5 - This sum is invested in NSC for 5 Years - Received Rs 45,597 at end of Year 10.

As illustrated above, you keep
receiving maturity proceeds at the end of year 6, 7, 8, 9 and 10. These
proceeds in turn can be reinvested in further NSCs of five years, maturing at
end of year 11, 12, 13, 14 and 15. This system creates a Ladder-like System, where every year there is a payout.
Our initial concern was that NSCs have a long maturity period with long lock-ins. This results in money getting stuck and reduction in liquidity. But this LADDER approach addresses this concern and generates cash (maturity proceeds) at the end of each year.

Now, you can continue this
ladder for as long as you like and see the magic of compounding take shape. I
know it is tough to plan for 10-15 years. But here, the best part is that once
you have invested Rs 1,00,000 in first year, it keeps on rolling without any
further investments. Also, interest earned by NSC in first 4 years is tax
exempt as it is reinvested and paid out only once at maturity. So tax benefits
are immense.

So, is this product for
everyone?

No. It is for those who believe in
long term wealth building using stable, reliable and risk free instruments. NSC can be one of the instruments if
you want to diversify your portfolio.

______

Thanks. The biggest problem I see why people from our generation don't invest in NSC is the lack of online options. For FD all transactions can be done while sitting at home with netbanking.

ReplyDelete@anon.coder

ReplyDeleteYou are right. If govt could come up with an online option, maybe a lot of people might get interested in this option.

I think doing a Recurring Deposit can also be beneficial...

ReplyDelete@Rahul

ReplyDeleteYes. RDs can be useful when you have some planned expenditures in near future. You can then save for the expenditure in disciplined manner.

A good idea stableinvestor.

ReplyDeleteCan you please inform us about the tax that we would have to pay for the interest.

Say I keep using this strategy for 20 years after investing the 1 lakh

The article mentions that: "Also, the interest income is tax-exempted"

ReplyDeleteYeah correct. However, I remember one of my friends saying that if the interest earned is greater than 10k per year then it will be liable to tax.

ReplyDeletePlease correct me if wrong.

Also, for NSC, Investment up to INR 1,00,000/- per annum qualifies for IT Rebate under section 80C of Income Tax Act.

What implications does this have, suppose I am willing to invest 2 lakh a year in NSC?

@wickedOne

ReplyDeleteThanks for the compliment.

And what you suggested can also be an option. You can start with NSCs from first year itself. :-)

@taklubaba

ReplyDeleteYou will only get a rebate upto a lac rupees.

This seems to be a good idea.But i have one question here..Suppose we carry with this "Ladder approach" for 25 years.What about the total tax that we will incur after the maturity of each FDs after their respective maturity s. Wont that eat a large chunk of the total amount that we will receive after lets say 25 years?

ReplyDeleteIn this particular example, the FD mature after 1, 2, 3, 4 & 5th year. So FD related taxation would have to be dealt with for first 5 years only. We switch to NSCs after the end of maturity of each of these FDs. But in case you want to make a ladder of FDs and continue it for 25 years, then its true that tax would reduce your earning susbstantially.

ReplyDeleteThanks for the reply.... I was planning to invest in NSC for one year and then keep renewing the matured NSCs as and when they mature.Is this a nice idea..if not can u suggest any other ways to better utilize this?

ReplyDeleteSeems like a good idea. We assume you would have invested in other asset classes as well. NSC alone may not be suffice.

ReplyDeleteYou mentioned "...the interest income is tax-exempted..."

ReplyDeleteThat is not completely true - OR so I understand. Here is what my understanding is, with regards to interest earned from NSC investments...

- The capital investment in N.S.C.s qualifies for rebate u/s 80C in the first year of investment.

- Thereafter (after completion of one year) for the next 5 years the annually accrued interest on N.S.C.s is eligible for rebate u/s 80C as it is considered reinvested in N.S.C.s

- Also this annually accrued interest is taxable on an accrual basis every year under the head ‘Income from Other Sources’.

- If the accrued interest is not taxed every year on an accrual basis than the entire income becomes taxable during maturity / withdrawal.

- 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.

Source 1:http://www.caclubindia.com/forum/nsc-interest-taxation-69147.asp#.UhTAMWf7q28

Source 2: http://taxguru.in/income-tax/nsc-tax-benefit.html

The Biggest problem with the current generation investing in such an Instrument is the tax liability..NSC investment is only viable for small amounts. There is no maximum limit for NSC investment and hence it would not be surprising if people had 1cr+ to invest in a safe,risk free instrument. But assuming its a 1 time investment you have an additional income of 9l pa out of which 1l is tax deductable. The problem now is since NSC is cumulative you would have to pay your taxes from other investments. If you choose to pay at the end of the maturity period of 10 years for a 1cr investment you would have accrued an interest of 1.34l which would then be taxable :(

ReplyDeletestable investor, coorect me if i am wrong. if we keep makingladder, there is no income or payout at the end of every yr. Am I right?

ReplyDeleteHmm... True. One can always exit the ladder when one wants to. Isn't it?

ReplyDelete