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In India, financial planning is critical for achieving long-term goals, and one important instrument that many people consider is the Tax Saving FD. A Tax Saving set Deposit (FD) not only provides a set return on investment, but it also allows you to save taxes under Section 80C of the Income Tax Act of 1961. While these tax-saving plans have many advantages, there are a few downsides that potential investors should consider.
In this article, we will go over everything you need to know about Tax Saving FDs, including what they are, how they work, the benefits and drawbacks, and, most importantly, whether they are the best investment option for you. We will also compare them to other tax-saving options and answer frequently asked questions to help you make an informed selection.
What is a Tax-Saving FD?
A Tax Saving FD is a fixed deposit scheme provided by banks and financial institutions in India that allows you to save taxes while earning fixed rates on your funds. Under Section 80C, the principal amount invested in a Tax Saving FD is deductible up to Rs. 1.5 lakh every fiscal year. These FDs have guaranteed returns that are unaffected by market changes, making them a safe and trustworthy investment alternative.
However, these FDs have a five-year lock-in term, which implies that the invested amount cannot be withdrawn before maturity. Furthermore, while the original amount is tax deductible, the interest collected is taxed based on your income bracket.
How Does Tax-Saving FD Work?
The method of investing in a Tax Savings FD is simple. This is how it works:
Choose a Bank or Financial Institution
The first step is to find a trustworthy bank or financial institution that offers tax-saving FDs. Before making a decision, make sure to evaluate the interest rates and amenities given by different organisations.
Investment Limits
The minimum investment is Rs. 100, with a maximum of Rs. 1.5 lakh per financial year.
Fixed Tenure
The Tax Savings FD requires a 5-year lock-in period. This implies you cannot make premature withdrawals, take out a loan, or use overdraft services against this deposit.
Interest Rates
Tax Saving FDs provide interest rates ranging from 5.5% to 7.75%, depending on the bank and the economic conditions at the time of investment. However, interest is taxable, and tax is deducted at the source (TDS) if it exceeds Rs. 40,000 per year for individuals (Rs. 50,000 for senior people).
Online Application
Many banks provide the ease of starting a Tax Saving FD online via their banking portals. After completing the Know Your Customer (KYC) process and sending the funds, you will receive a deposit confirmation, along with the interest rate and maturity date.
Banks offering Tax-Saving FD
| Bank | Interest Rate |
| Suryoday Small Finance Bank | 8.25% |
| Unity Small Finance Bank | 8.15% |
| Utkarsh Small Finance Bank | 7.75% |
| AU Small Finance Bank | 7.25% |
| Equitas Small Finance Bank | 7.25% |
| Jana Small Finance Bank | 7.25% |
| Ujjivan Small Finance Bank | 7.20% |
Source: The Economic Times
Pros of Tax-Saving FDs
Tax Benefits
The most appealing aspect of a Tax Savings FD is the tax deduction it provides. Section 80C of the Income Tax Act allows for deductions of up to Rs. 1.5 lakh per year. This can drastically reduce your taxable income, cutting your tax bill.
Guaranteed Returns
Tax Saving FDs, unlike equity-linked securities, offer set and guaranteed returns. Once you invest, the interest rate remains fixed for the duration of the FD, ensuring that your funds increase steadily over time.
Low-Risk Investment
Banks offer Tax Saving FDs, which are supervised by the Reserve Bank of India (RBI), making them one of the safest investment options. Your investment is safeguarded, and you have no danger of losing money due to market volatility, making it an excellent alternative for risk-averse investors.
Flexible Investment Amounts
You can begin investing as low as Rs. 100, and the most amount you can invest in a fiscal year is Rs. 1.5 lakh. This makes it appropriate for those with varying financial situations.
Loan Facility
Although early withdrawals are not permitted, certain banks provide loans on Tax Saving FDs after the lock-in period expires. This can offer financial flexibility if necessary.
Cons of Tax-Saving FDs
Lock-In Period
One significant disadvantage of Tax Saving FDs is the mandated 5-year lock-in period. During this period, you cannot withdraw or terminate the FD without incurring penalties, which may limit your financial flexibility in the event of an emergency.
Taxable Interest
While the principal amount is tax deductible, the interest earned is taxable. The interest is applied to your income and taxed at the applicable income tax rate. This can diminish overall returns, particularly for those in higher tax brackets.
Inflation Risk
The set interest rate on Tax Savings FDs may not always keep pace with inflation. As a result, the actual value of your returns may decline over time. Inflation reduces purchasing power, and if the inflation rate exceeds the interest generated, your investment may not grow in real terms.
Lower Returns Compared to Other Instruments
Tax Saving FDs offer lesser returns than other tax-saving investment options such as Equity Linked Savings Schemes (ELSS) or Public Provident Funds (PPF). ELSS funds, for example, can provide returns of 12% to 15% with a shorter lock-in period of only three years.
No Premature Withdrawal
Tax Saving FDs, unlike other savings options such as PPF or NPS, do not allow for premature withdrawals and do not offer overdraft capabilities during the lock-in period.
Who Should Invest in Tax-Saving FDs?
Risk-Averse Investors
If you choose security and consistency over bigger profits, Tax Saving FDs are a solid investment option. Your principal is safeguarded, and returns are assured.
Taxpayers Seeking Deductions
Individuals in higher tax bands can benefit from the tax deductions available under Section 80C, which can reduce their taxable income by up to Rs. 1.5 lakh per year.
Short to Medium-Term Goals
If you have short to medium-term financial goals, like purchasing a car, supporting college, or arranging a wedding, Tax Saving FDs provide predictable 5-year returns.
Low-Risk Tolerance
Investors with a low risk tolerance who are not comfortable with market-linked products such as ELSS or mutual funds can seek consistent returns by investing in Tax Saving FDs.
Key Considerations Before Investing in Tax-Saving FDs
Assess Your Financial Goals
Before investing, consider your financial objectives and risk tolerance. If you have a lengthy time horizon and can tolerate moderate risk, market-linked investments such as ELSS may provide higher returns.
Compare Interest Rates
Different banks provide Tax Saving FDs with varying interest rates. It is critical to evaluate rates and select a bank that offers the best returns on your investment.
Understand Tax Implications
The primary investment saves you taxes, but the interest earned is taxable. Make sure you account for this tax due when preparing your overall returns.
Diversify Your Portfolio
Instead of depending just on Tax Saving FDs, diversify your portfolio with other investment options such as PPF, ELSS, and NPS to achieve greater overall growth.
Conclusion
Tax Saving FDs provide a dependable and secure way to save taxes while earning set returns. They are perfect for risk-averse investors who want a secure investment alternative to accomplish their short-term financial objectives. However, the 5-year lock-in period, taxable interest, and lower yields compared to other tax-saving vehicles necessitate weighing the benefits and drawbacks before investing. Evaluate your financial status, evaluate your options, and select the best investment for your long-term goals.