Mar 15, 2010

Is it worth Investing in Kisan Vikas Patra (KVP)?


So, you never gave a serious thought to Kisan Vikas Patra (KVP) as an alternative debt instrument because you did think that it is only meant for farmers...Didn't you? I’ve also been so busy promoting PPF that KVP almost escaped attention. But then Purab asked [see: What is right time to buy a home?],

“I have 3 Lakh to invest, how is Kisan vikas patra for mid/long term investment.”

Let me rephrase the question

Other than the tax-saving debt instruments available for investments (e.g. PPF, NSC, Bank FDs), which debt instruments can be regarded as good from medium to long term investment point of view?

Due to the current low-interest rate regime, small savings instruments have once again started looking attractive. KVP is
also a small saving instrument available at post offices offering a pre-tax return of 8.41% per annum (your money doubles in 8 years & 7 months).


Basic Features:
1. Easy to purchase: Available in denominations of Rs 100, Rs 500, Rs 1000, Rs 5000, Rs 10,000 and Rs 50,000. No a/c opening hassles are involved. Just go to a post office fill a form, hand over the cash or cheque / DD and you’re done. Further there is no limit as to number of KVP certificates you can purchase or maximum amount you can invest.

2. Post-tax Yield: The interest is taxable on annual basis (although no TDS is involved). The post-tax yield from KVP depends on the marginal tax rate that will be applicable to you.

3. Premature encashment is possible just after 2.5 years (2 years & 6 months) but it is very costly—see the table:

Period--------------------------Yield---------------Reduction in Yield

Up to 2.5 years -----------------NA--------------------------NA

2.5 years to 3 years-------------6.5%-----------------------1.91%

3.5 years to 4.5 years-----------7.0%----------------------1.41%

5 years to 6 years----------------7.5%----------------------0.91%

6.5 years to 8 years--------------8.0%----------------------0.41%

8 years & 7 months--------------8.4%----------------------nil


4. Loan facility is also available against KVP by pledging it with the bank.


Comparison with PPF & NSC:
No doubt PPF, NSC, Tax-saving bank FDs have an edge over KVPs due to associated tax benefits. But once you exhaust your section 80C limit & PPF investment limit, investing in KVP becomes an attractive proposition.

KVP vs. PPF
PPF maintains its superiority over all other small-saving schemes (even ignoring the section 80C tax benefit) because the post-tax yield of PPF is substantially higher than all other debt instruments. PPF is the only debt instrument (other than the EPF), where your interest income is completely exempt. Accordingly the tax-free interest of 8% from PPF is much better than 8.41% taxable interest from KVP. However, if your total income is either nil or less than basic exemption limit, then KVP will score over PPF.

Even after implementation of Direct Tax Code (DTC) which will make the PPF withdrawals taxable, post-tax returns of PPF will be better than KVP.

KVP vs. NSC
Now, let’s come to KVP vs. NSC. Isn’t NSC a better debt instrument than KVP (even after ignoring section 80C tax benefit on the amount invested in NSC)? …Let’s see

1. Returns: Yield is 8.40% from KVP as against 8.16% from NSC.

2. Taxation: First, NSC is one of the eligible instrument u/s 80C i.e., the amount of your income invested in NSC gets exempted from tax. Second, returns of both the instruments are chargeable to tax. But unlike KVP, NSC interest is again eligible for deduction u/s 80C. But if your section 80C limit is already exhausted, then this tax benefit offered on NSC is of no good.

In short, considering tax benefits NSC is undoubtedly better than KVP (Note: there won’t be any more tax benefit on NSC after implementation of DTC). However, if tax is not the criteria, then KVP returns are a little better than NSC and with a longer investment period of about 2.5 years.


Comparison with other Debt Instruments:
Over the last year, returns offered on bank FDs are steadily coming down. At present 5- to 10-yr bank FDs are offering interest in the range of 7.25% to 7.75%.

The YTM of non-convertible debentures is also coming down. The following is the maximum YTM of NCDs issues during last one year

TATA Capital NCD -------------->12%
Shriram Transport NCD--------->11.50%
L&T Finance NCD (1st issue)--->10.50%
L&T Finance NCD (2nd Issue)-->8.58%

Although the YTM of 8.58% (accompanied with interest rate risk) on the L&T finance NCD 2nd issue in February 2010 was almost at par with KVP, the duration was 3 years as against almost 9 years of KVP.

Coming to medium and long term debt mutual funds, the 5-Yr category average returns are somewhere between (As on March 2010) 6 and 7 percent with some tax benefit due to tax arbitrage. Moreover, when there are chances of increasing interest rates, it is very risky to invest in long term debt funds.

So, due to above reasons, KVPs have started looking very attractive debt instrument offering relatively better returns without any risk.


Conclusion:
In a nutshell, if you’ve completed your tax savings and are looking for a debt instrument offering assured good returns combined with safety and liquidity then KVP is a good choice.

In other words, invest in KVP if you’re done with your tax saving investments and further exhausted your PPF investment limit (including your spouse & children) but make up your mind that you’ll remain invested till the maturity because if you make a premature exit, your effective yield will be considerably lower (the facility of making an early exit can be exercised in an emergency by sacrificing some returns).


Also see:

1. Practical Tips for Investing in FDs
2.
Why should you invest in gold ETFs?

10 comments:

  1. In KVP, you would then have to make a bulk amount as investment, right, unlike a PPF for proper benefit? If you deposit 500 Rs today and then it becomes 1000 after 8 yrs 7 months, then it is of no use. But in a PPF, different amounts can be deposited as and when required. Will that not be an easier and more flexible thing to do?

    ReplyDelete
  2. Pradeep,

    Very correct…although it is also possible to invest different amounts in KVP over a period of time, but then unlike PPF each KVP certificate will have different maturity date.

    ReplyDelete
  3. Hi, If i invest Rs one lakh in KVP, it becomes 2 lakhs in 8.7 years.
    Could you tell me exactly out of that 2 lakh what is the amount that would be deducted as tax.

    Rg,
    Ankur

    ReplyDelete
  4. Ankur,

    There's no tds in case of KVPs.

    ReplyDelete
  5. AnonymousJune 10, 2010

    I am a housewife and i dont earn any income is KVP good choice of investment for me will i be required to pay tax on interest suppose if i want to invest Rs. 30000/- tell me will i incur tax on interest rate if i invest in KVP also please tell me how much I can invest so that i dont get tax on interest

    ReplyDelete
  6. AnonymousJune 25, 2010

    I am a housewife, having one KVP of Rs10000/- purchsed in May'1999, its got matured in 2005 (double in 6+years) but due to various reason am not able to encash it. Currently I am in Chennai these days and i have purchased it from Dewas (MP), pls suggest the following:
    1. How much amount i can get now.
    2. I can not go Dewas (MP) from where i purchased this KVP just because of this reason so pls suggest some easier way.

    ReplyDelete
  7. Go Dewas MP and again invest the maturity amount in KVP and ask postmaster to registered the KVP from 2005

    ReplyDelete
  8. I am a housewife and want to invest 100000 rs,but i am worried that TDS would be deducted on the returns i get n will eat away the fruits of interest as i am not filing my returns. could u pl suggeststhe best way for my investment where TDS would not be deducted????

    ReplyDelete
  9. i m bhanuben m. fachara.i had purchase 5 1/2 year kvp in july 2003 for 8 year plan. so my que. is how can i my money back after complete my plan period ? Can i see my kvp plan update on online ? plz suggest me earlier as possible.

    Thanks,
    B.M.Fachara
    Rajkot.

    ReplyDelete
  10. With KVP scheme taken off, what are the alternatives now?

    ReplyDelete

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