Tax-saving Fixed Deposit Or Tax-saving Fund?

Equity-linked savings schemes and five-year fixed deposits with banks or post offices are two of the most popular tax-saving investments

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Tax-filing season brings a rush of people scrambling to file their returns. Many judicious planners implement tax-saving strategies, but others do it at the last minute.

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Equity-linked savings schemes (ELSS) and five-year fixed deposits with banks or post offices are two of the most popular tax-saving investments. Under section 80C of the Income Tax Act, 1961, both offer a tax deduction of up to INR 1,50,000, but they have different investment implications for investors.

What is ELSS?

ELSS is a mutual fund that focuses on stocks, and at least 80 per cent of its investments come from stock holdings. These funds also have a debt component. ELSS funds enjoy a unique tax benefit, making them both investment and tax-saving vehicles.

What is a tax-saving FD?

As the name indicates, this is a bank fixed deposit eligible for tax deductions. The lock-in period is five years. Tax saving FDs and time deposits with a maturity period of five years can be purchased from private and public banks, as well as post offices. The interest rates might differ from bank to bank or scheme to scheme.

Key features of ELSS

1. The investment in ELSS funds is eligible for tax benefits under section 80C of the Income Tax Act 1961. This benefit will be applicable on an annual basis only during the financial year you make the investments in them.

2. ELSS Funds seek long-term capital appreciation by investing predominantly in equities. They may also invest in other asset classes such as fixed income securities, money market instruments or derivatives.

3. Investments made in ELSS can also be used to fulfil your long-term goals such as buying a house or child's education. You can even invest in ELSS through monthly SIPs.

4. ELSS funds offer Long-term growth with low volatility.

5. ELSS funds offer better returns than most other debt-oriented savings plans such as Public Provident Fund (PPF), National Savings Certificate (NSC), Post Office Monthly Income Scheme (MIS), Fixed Deposit and others.

6. These funds give access to the equity markets that may otherwise be inaccessible to retail investors due to lack of knowledge and time.

7. ELSS funds have a lock-in period of just three years. Its lock-in period is lowest among tax-saving instruments. After this period, investors can either redeem their investments or switch to another scheme in order to take advantage of any subsequent changes in the market or the investment objective.

8. ELSS funds are managed by professional fund managers who study the market constantly and understand its movements.

9. ELSS funds are open-ended, and therefore, they are available for purchase/sale throughout the year.

Key features of fixed deposits

Tax-saving bank deposits have the following features:

  1. Debt or fixed-income instrument with a bank
  2. Lock-in period of five years for taxation purposes
  3. Low risk with assured returns
  4. Interest pay-out schedule can be monthly, quarterly, half-yearly, annually, or at maturity
  5. Senior citizens are eligible for higher interest rates
  6. Eligible for a tax deduction of up to Rs.1,50,000 p.a. under Section 80C of the Income Tax Act
  7. Interest earned will be taxed according to the income slab of the investor

What should you invest in?

If you're thinking about how to save taxes through investments, both ELSS and FDs may seem appealing. It is important to determine your individual financial circumstances before making decisions. An individual's age, income, risk capacity, and time should be considered while making an investing decision.

In essence, ELSS is a mutual fund investment, suited for investors with a high level of risk tolerance. Tax-paying investors invest in ELSS to reduce their tax liability while increasing their wealth. Young investors may find ELSS appealing due to the amount of time they have to take on risks. Additionally, ELSS has the lowest lock-in period among other tax-saving securities, which makes it an attractive investment for those who want to commit funds only for three years. ELSS also has the potential to meet specific financial goals due to its ability to deliver reasonable returns.

The convenience and safety of fixed deposits make them an ideal investment for investors having low risk tolerance. Many older investors and senior citizens favour fixed deposits over other options. Despite the lock-in period being five years, the returns are guaranteed, but they are still lower than other tax-saving instruments. FDs are also convenient because anyone with a bank account can invest in them. Either they can visit the branch or open a tax-saving FD online.

Comparison

Feature

ELSS

Tax-Saving FD

Tenure

3-year lock-in period, can reinvest afterwards

Minimum 5-year lock-in period but can be extended up to 10 years

Tax deduction

Up to INR 1,50,000 p.a. under Section 80C

Up to INR 1,50,000 p.a. under Section 80C

Tax Implication

Gains from ELSS funds held for more than 12 months attract long-term capital gains tax at 10 per cent if the total long term capital gains amount from equity oriented mutual funds/ equity shares exceed Rs. 1,00,000 in a year.

Interest taxed based on income slab

Risks

High

Low

Conclusion

When it comes to saving and investing, there is no one size fits all solution. Investing is a complex process that requires you to do your research and examine how mutual funds and fixed deposit fit into your overall financial scheme of things. It would also make sense to spread your investments across various instruments so that you benefit from diversification.