PPF vs 5-year Post Office FD: Does tax-free 7.1% beat taxable 7.5%? Check calculations

PPF currently offers 7.1% interest, while the five-year Post Office Time Deposit offers a higher rate of 7.5%. | ChatGPT generated/Representative Image

Both Public Provident Fund (PPF) and Post Office Fixed Deposits are safe investment options as they are not linked to the markets. Both are government-backed savings schemes, and both offer interest, but there is one difference that can make choosing between them confusing. PPF currently offers 7.1 per cent interest, while the five-year Post Office Time Deposit offers a higher rate of 7.5 per cent.

At first glance, the five-year deposit looks more attractive. After all, it offers a higher interest rate. But the full picture changes when income tax is taken into account. Interest earned on PPF is tax-free, while interest from a Post Office Time Deposit is taxable according to the investor's applicable tax rules.

So, does the lower 7.1 per cent PPF rate actually leave more money in the investor's hands? Let us understand how the two schemes work and what makes their returns different.

How is interest calculated?

PPF interest is calculated every month on the lowest balance between the close of the fifth day and the end of the month. The interest is credited to the account at the end of the financial year. This means money deposited before the fifth-day cut-off can earn interest for that month, subject to the scheme rules.

The five-year Post Office FD follows a different method. Its interest is compounded quarterly but paid to the account holder annually.

An investor can receive the annual interest and use it for expenses or invest it elsewhere. However, interest that becomes due but is not withdrawn does not automatically earn additional interest within the same time deposit. PPF interest, on the other hand, remains in the account and becomes part of the balance on which future interest is calculated. This difference is important when comparing returns over several years.

How much can Rs 1 lakh earn?

Suppose someone has Rs 1 lakh to invest.

At 7.1 per cent, Rs 1 lakh in PPF can earn around Rs 7,100 over a full year, assuming the entire amount earns interest for all 12 months and the rate remains unchanged. The interest is added to the PPF balance rather than being paid out.

Now consider Rs 1 lakh invested in a five-year Post Office FD at 7.5 per cent.

With quarterly compounding, the annual interest works out to approximately Rs 7,714 before tax. This is higher than the PPF interest for the same initial amount.

But the investor may not get to keep the entire Rs 7,714 because the Post Office FD interest is taxable.

These figures are meant to explain the difference in interest and tax treatment. They are not a five-year maturity comparison, as PPF has a much longer original tenure.

How does income tax change returns?

This is where the comparison becomes interesting. Suppose an investor earns approximately Rs 7,714 as annual interest from the five-year Post Office FD. If the interest is effectively taxed at 10 per cent, the amount left after tax would be around Rs 6,943.

At an effective tax rate of 20 per cent, the amount would fall to approximately Rs 6,171. If the effective tax rate is 30 per cent, the investor would retain roughly Rs 5,400.

These are simplified calculations and do not separately include cess, surcharge or other tax adjustments.

In comparison, the Rs 7,100 interest earned on PPF remains tax-free under the applicable rules.

For an investor whose FD interest is taxed at a higher rate, PPF can therefore provide a better return after tax, even though its headline interest rate is lower.

However, the result will not be the same for everyone.

If an investor has little or no income-tax liability, the taxable interest from the Post Office FD may still leave a higher return. The investor's actual tax position matters more than simply comparing the published interest rates.