Tax-saving fixed deposits are becoming popular among investors

People keep searching for the options to save tax. As the March is approaching tax investments have probably become the priority. Generally consider insurance, equity-linked saving schemes (ELSS), PPF to get some tax exemptions. Nowadays five-year tax-saver fixed deposits (FDs) are becoming popular among tax savers.

The government in its Budget 2006 had extended tax benefits to five-year tax-saver deposits. According to the existing provision, you are eligible for exemption on five-year deposits on investments up to Rs 1 lakh. These fixed deposits will not have the option of premature withdrawal and will be locked for a five-year period from the effective policy date. Secondly, these fixed deposits cannot be undertaken as guarantee to secure a loan to meet your liquidity needs.

Also, banks do not give overdraft facility on tax-saver deposits. 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.

Unlike the accustomed fixed-deposit products, these tax-saver FDs do not have the sweep-in facility. This means, the surplus funds in the savings account will not be automatically invested in this fixed deposit.

Similar to life insurance policies and mutual funds (ELSS), this exemption comes under Section 80 C of the Income Tax Act, 1961. One thing is clear that this five-year bank fixed deposits offer tax benefits when you invest in them. Some industry experts have a view that these five-year tax-saver FDs are better than PPF.

In PPF, your money will be locked for a period of 15 years. A loan can be taken 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. Moreover there is an option of with drawing the money after completion of 5 years from the end of the year of opening the account. But in this case, a five-year fixed deposit can score over the PPF due to higher lock-in period.

The interest rate on most of these tax-saver deposits range between 8.5-9% p.a. PPF and NSC gets you 8% p.a. However 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.

Kartik Jhaveri, a certified financial planner and wealth manager with Transcend India explains, as the returns on these deposits are taxable, the net return depends upon the income tax bracket in which you fall. 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.

Though there are various tax-saving alternatives available in the market. But a 5-year fixed deposit is a near risk-free investment. Before signing on the dotted lines study its benefits carefully.