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Do long term FDs create value as a Section 80C tax saving tool?
05 Jan 2023

Tax Saving Fixed Deposits are a recent addition to the list of items eligible for deduction under Section 80C of the Income Tax Act. The Tax Saving FD is like any other FD with most banks paying out an interest in the range of 7.25% to 7.50% per annum. Of course, most of these banks will pay an additional 0.50% in case of senior citizens. For all practical purposes, this FD is exactly like any other bank FD except that there is a 5-year compulsory lock-in period once you invest in this Tax Saving FD. Let us understand the salient features of the tax saving FD..
Key features of the Tax Saving Fixed Deposit..

The tax saving FD can be invested in by any resident India who has a PAN card. It can be held in the name of an individual or in the name of a Hindu Undivided Family (HUF).

Tax saving FDs can be held either in individual names on in joint names. Remember, the tax exemption under Section 80C will only be available in case of the primary holder and not to the secondary holder.

The tax saving FD has a compulsory lock-in period of 5 years. During this period the FD cannot be withdrawn nor can you take a loan against this FD. This makes it a fairly illiquid asset from your portfolio point of view.

The minimum investment is Rs.100 and you can later add in multiples of Rs.100. However, the maximum investment in tax saving FDs in any one year is capped at an outer limit of Rs.150,000/-. You cannot invest more than that in a single year.

The interest paid on these deposits is fully taxable at your peak rate of tax. Depending on whether you are in the 20% bracket or the 30% bracket, the interest on these FDs will be included in your total income and taxed at that rate.

The bank will deduct TDS at the time of crediting the interest. If you have already submitted PAN details then the TDS will be deducted at 10%, else it will be deducted at 20%. Of course, if your total interest income in the year is less than Rs.10,000 then you furnish the certificate and the TDS will not be deducted.

The principal attractiveness of the tax saving FD arises from its 100% safety and the tax exemption under Section 80C. Due to the tax exemption the yield will be above 14% in case you are in the 30% tax bracket. However, if you consider the tax payable on the interest income, then the effective yield will be much lower.

Tax saving FDs versus PPF..
One of the popular means of saving tax via Section 80C has been the public provident fund (PPF). So how does the tax saving FD compare with the PPF? Let us compare on the 4 key parameters..

In terms of risk, both the PPF and the bank FDs are government backed. Hence there is little to choose between these two in terms of safety. Both are equally safe and secure.

In terms of returns, the yields on both the PPF and the long term FD is almost the same. In fact, the returns on PPF are slightly higher than that of the FD as PPF rates are fixed by the government.

There is a major difference when it comes to liquidity. While tax saving FD has a lock-in of 5 years, the PPF has a lock-in of 15 years. But, you can withdraw your PPF funds after 7 years and you can even take a loan against your PPF after completion of 5 years. But it must be said that the tax saving FD does score higher on the liquidity front.

Lastly, we come to the tax efficiency front. This is where the PPF scores. Both the PPF and tax saving FD offer benefits of Section 80C in the year of investment. However, the interest on tax saving FDs is fully taxable in the hands of the investor while in case of PPF, the interest is entirely tax-free in the hands of the investor.

To summarize, while the tax saving FD scores on liquidity the PPF scores on greater tax-efficiency. As most investors opine; they do not see a big advantage in going for tax saving FDs over PPF.
A better way to play your Section 80C..
Is there a better way to play your Section 80C? The answer is "Yes". For safety and security you can allocate part of your Section 80C allocation to PPF. The balance can be invested in an ELSS fund where you get the tax benefit, you get tax-free dividends, tax-free capital gains, liquidity in 3 years and wealth creation. The balance can be invested in a debt fund rather than in an FD. That way the dividends on your debt fund will be tax free and you will stand to benefit when interest rates move down. That market benefit is something you do not get in FDs. The moral of the story is that you should buy the Tax Saving FD option with a pinch of salt!

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