Tax saving fixed deposits: How to make the most of them

Over the past year (since mid-2022), the Reserve Bank of India (RBI) increased fixed deposit (FD) interest rates to combat high inflation. Banks also increased their deposit and lending rates in line with RBI’s interest rate hikes. The high interest rates on FDs have brought cheer to fixed-income investors after the painful last few years of low interest rates.

Currently, fixed-income investors are spoilt for choice among fixed-income products such as bank fixed deposits, corporate bonds, debt mutual funds, small saving schemes, etc. This article will focus on tax saving fixed deposits that give investors an ideal combination of good interest rates, safety, and tax benefits. 

But before discussing tax saving fixed deposits, let us understand what fixed deposits are.

What is a fixed deposit?

A customer invests a lump sum in a Fixed Deposit at a specified interest rate for a specified period. They can choose the interest payment frequency as monthly, quarterly, or on maturity. The interest amount is credited to the depositor’s savings account at the specified frequency. 

On maturity, the depositor gets back the principal amount.

An FD in which the interest is paid on maturity along with the principal amount is known as a cumulative fixed deposit. The depositor can give maturity instructions when making the FD and can include the auto-renewal of the deposit or principal sum credit to the depositor’s saving account. 

Fixed deposits can be of various types, one of which is the tax saving fixed deposit.

What is a tax saving fixed deposit?

A tax saving FD offers tax benefits at the time of investment. The depositor can avail of a deduction from taxable income under Section 80C of the Income Tax Act. The maximum deduction allowed in a financial year is the amount invested or Rs 1,50,000, whichever is lower.

Apart from the tax saving fixed deposit, Section 80C of the Income Tax Act allows a deduction for various other financial products such as life insurance, equity-linked saving scheme (ELSS), PPF, NSC, etc. However, the maximum deduction allowed for all financial products covered under Section 80C is Rs 1,50,000 in a financial year.

While you can get tax benefits on a tax saving deposit at the time of investing, the interest accrued is taxable. The interest amount is added to the depositor’s overall income and taxed at the slab rate.

Also read: https://www.idfcfirstbank.com/finfirst-blogs/finance/8-tax-saving-investment-plans

How is a tax saving fixed deposit different from a regular fixed deposit?
 

Certain features of a tax saving FD make it different from regular fixed deposits. Here are some of these unique features:

·     Lock-in period of 5 years: The tax saving fixed deposit has a fixed tenure and a lock-in period of five years. During the lock-in period, partial withdrawals are not allowed. Premature withdrawal of the fixed deposit is also not allowed. In the case of regular fixed deposits, partial withdrawal and premature withdrawal are allowed. However, there may be a penalty that differs from bank to bank.
 

·     Tax benefit: The tax saving fixed deposit gives a tax benefit at the time of investment under Section 80C of the Income Tax Act. Regular fixed deposits don’t provide a tax benefit.
 

·     Cannot be used as collateral for loans: The tax saving fixed deposit cannot be used as collateral for taking a loan. Regular fixed deposits can be used as collateral to take a loan from the bank where the fixed deposit was made. Usually, banks give a loan of up to 80%-90% of the regular fixed deposit amount.

Also read: https://www.idfcfirstbank.com/finfirst-blogs/finance/how-women-can-start-their-investment-journey

Advantages of a tax saving fixed deposit

Investors are spoilt for choice since most fixed-income products' interest rates are high. However, the tax saving fixed deposit offers the following advantages.

·       Safety
 

Bank fixed deposits are usually safer than other fixed-income products like corporate bonds. While corporate bonds have a credit default risk, there is no such risk in fixed deposits unless the bank collapses. In the case of a bank liquidation, deposits of up to Rs 5 lakh per customer are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC), which is a subsidiary of the RBI. 

·       Tax benefits
 

Tax deduction from taxable income under Section 80C is one of the biggest advantages of a tax saving fixed deposit. We have already discussed the tax benefit in detail earlier.

·       High interest rate that remains fixed for the entire tenure
 

Currently, tax saving fixed deposits are offering a high interest rate. The FD interest rate that most banks offer is in the range of 6.5% to 8.5% p.a. The interest rate specified at the time of making the FD remains constant throughout the tenure till maturity. This fixed interest rate is a significant advantage compared to floating interest rate products such as Public Provident Fund (PPF), where the interest rate is revised every quarter.

·       Low minimum investment amount
 

The minimum investment amount for fixed deposits varies among banks. The minimum amount for private banks is usually between Rs 10,000 and Rs 25,000. Usually, public sector banks and small finance banks allow depositors to make a tax saving FD with a minimum investment amount of Rs 1000. It is affordable for most people across income groups.

It is simple and convenient to make an FD from the comfort of your home through the bank's website or mobile app. You also have the option to visit the bank branch to make the fixed deposit if you wish. 

·       Higher interest rates for senior citizens
 

Banks give senior citizens a higher FD interest rate than other depositors. The interest rate is usually 0.25% to 1.00% higher for senior citizens. Apart from senior citizens, some banks offer higher interest rates for women, staff, etc. 

Also read: https://www.idfcfirstbank.com/finfirst-blogs/finance/investment-plan-for-beginners

Some disadvantages of tax saving fixed deposits
 

While tax saving FDs have many advantages, they also have a few disadvantages:

·     The lock-in period of five years is greater than the lock-in period of three years for ELSS and traditional life insurance policies

·     You cannot make a partial withdrawal or premature withdrawal from a tax saving fixed deposit during the five-year tenure

·     Banks don’t give a loan against the security of a tax saving fixed deposit

·     In the case of some private banks, the minimum deposit amount starts from Rs 25,000, which may be on the high side for some depositors

·     The interest earned on a fixed deposit is taxed at the individual’s slab rate. While PPF interest is tax-free, ELSS redemption enjoys a favourable long-term capital gains tax rate of 10% (after exemption of the first Rs 1 lakh LTCG (long term capital gain) in a financial year)

Asset allocation: Build a diversified investment portfolio

You should follow appropriate asset allocation based on your risk profile. You may diversify your investment portfolio across equity mutual funds, fixed income, gold, etc. In a diversified portfolio, equity provides growth, fixed income provides stability, and gold provides a hedge against inflation. A diversified portfolio provides better risk-adjusted returns. You may allocate some portion of your fixed-income portfolio to tax saving fixed deposits to get a good combination of safety, tax benefits, and good returns. 

Why not open a  tax saving fixed deposit  with IDFC FIRST Bank? The bank pays an attractive interest rate and senior citizens get an additional 0.50% interest rate. You can also go to the IDFC FIRST Bank website and Use the FD calculator to know the interest and maturity amount.

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.