Conservative investors tend to invest in fixed deposits (FDs) to ensure guaranteed returns on their investment. And when they become entitled to save income tax on it, it is like a frosting on the cake.
The FDs that allow investors to save income tax are known as tax saving FDs and give slightly higher returns than normal term deposits. But the catch is that they have a lock in period of five years.
Since commercial banks have been raising interest rates on their fixed deposits (FDS) since RBI started raising key interest rate in May 2022, the current interest rates have reached high levels that are tempting enough for investors to lock their savings into these deposits.
What are tax saving FDs?
One can invest any amount up to ₹1.5 lakh in a tax-saving fixed deposit. This investment enables investors to save tax under section 80C of the Income Tax (I-T) Act.
The tax saving FD has a lock in period of five years. Some banks also give the option of booking with monthly or quarterly pay-out.
Also, in case the bank account is a joint account, tax exemption will be given only to the first holder of the deposit
Why should you invest?
First and foremost, the tax-free FDs allow investors to save income tax up to ₹1,50,000 per annum. But this tax saving threshold of ₹1.5 lakh is cumulative, and applies to all the investments eligible for 80C exemptions.
For example, if someone has made an investment of ₹1.40 lakh in national savings certificate (NSC) and another ₹one lakh in the tax saving FDs, then s/he can claim tax exemption of only ₹10,000 and not for entire ₹one lakh.
However, the interest earned on tax-saving FDs is taxable and banks usually deduct TDS (tax deducted at source) when interest earned exceeds ₹40,000 (50,000) in case of senior citizens.
Second, the returns are assured. Just as any other FD with a bank, tax free FDs also come with bank guarantees under DICGC (Deposit Insurance and Credit Guarantee Corporation). So, investors don’t need to worry about any possible default.
Third, tax-free deposits offer relatively higher returns than regular FDs. On the top of it, tax saving makes the returns even higher.
However, investors must be aware of the fact that these deposits are usually not considered as a collateral for availing loan facility.