Tax-saving fixed deposits good tool for investors

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March is just a month away and tax investments are probably taking priority. The usual suspects are insurance, equity-linked saving schemes (ELSS), PPF to seek some tax exemptions. Another instrument, which is getting popular among tax savers, is the five-year tax-saver fixed deposits (FDs).

Five-year tax-saver FDs

In Budget 2006, the government extended tax benefits to five-year tax-saver deposits. As per the existing provision, you are eligible for exemption on five-year deposits on investments up to Rs 1 lakh. These fixed deposits will be locked for a five-year period from the effective policy date. So, you cannot exercise the option of premature withdrawal. Secondly, you cannot pledge the term deposit as collateral to secure a loan to meet your liquidity needs. Similarly, banks do not offer overdraft facility on tax-saver deposits.

Unlike the plain vanilla fixed-deposit products, these tax-saver FDs do not have the sweep-in facility. This implies, you cannot link fixed deposit to the savings account whereby the surplus funds in the savings account can be automatically invested in this fixed deposit.

In addition, there is no overdraft facility available on the tax-saver FD. As this instrument of saving money is special due to its tax-saving status, banks do not extend relationship benefits on the tax-saver FD.

Other alternatives

Akin to life insurance policies and mutual funds (ELSS), this exemption comes under Section 80 C of the Income Tax Act, 1961. However, what you need to know is these five-year bank fixed deposits offer tax benefits when you invest in them. Some experts feel five-year tax-saver FDs could be better than PPF.

In case of PPF, you money will be locked for a period of 15 years. You can avail of loans against the PPF account after completion of one year from the end of the financial year of opening of the account and before completion of the fifth year. You can withdraw money after completion of 5 years from the end of the year of opening the account. In this case, a five-year fixed deposit can score over the PPF due to higher lock-in period.

Calculate your yield

Most of these tax-saver deposits are today offering interest in the range of 8.5-9% p.a. PPF and NSC fetches you 8% p.a. Though the interest on deposits is tax free in case of PPF. Interest is generally calculated on a quarterly basis and the interest reinvested into the fixed deposit.

However, since the returns on these deposits are taxable, the net return depends upon the income tax bracket in which you fall, explains Kartik Jhaveri, a certified financial planner and wealth manager with Transcend India. Let us assume that your tax-saver deposit is fetching you a return of 8.5% p.a. Now, if you fall in the 20% income tax bracket then your effective post-tax return would be around 12.4% p.a. This is after taking into account the tax rebate earned as well as tax paid on interest earned.

In short, there is various tax-saving alternatives available in the market. A 5-year fixed deposit, nevertheless, is a near risk-free investment.