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Advantages and Disadvantages of Tax-Saving Fixed Deposits

Tax-saving fixed deposits provide a secure option for individuals seeking to save on taxes* in India. With a five-year lock-in period, they offer stable returns and deductions under Section 80C, making them ideal for risk-averse investors and those with specific financial goals.

When managing our money, tax-saving fixed deposits can be a helpful tool. They offer a safe way to save while also reducing our tax* liability. But like everything, they come with their own good and not-so-good points. This blog is here to break it down for you in simple terms. 
 

This blog will discuss the pros and cons of tax-saving fixed deposits. By the end, you will have a clear picture of whether this investment tool is the right choice for you or not.
 

So, let us get started!

What are Tax-Saving Fixed Deposits and How Do They Work?

Tax-saving fixed deposit is a type of FD offered by banks in India that comes with tax benefits under Section 80C of the Income Tax Act. These deposits have a lock-in period of five years. They are primarily designed to encourage individuals to save and invest while reducing their taxable income.
 

Also, if you were thinking, ‘Can FD be used for tax exemption?’ The answer is yes! Investors can claim a deduction of up to ₹1.5 lakh from their taxable income in a financial year by investing in tax-saving fixed deposits. 
 

Interest rates on tax-saving fixed deposits are generally competitive with regular fixed deposits, and they provide a fixed return on investment. However, the interest earned is taxable at the investor's applicable income tax rate.
 

This separates them from tax-saving investments like the Public Provident Fund (PPF) and National Savings Certificate (NSC), where the interest is tax-exempt.
 

Premature withdrawals against tax-saving fixed deposits are not permissible, providing a disciplined approach to long-term savings. Furthermore, these deposits cannot be pledged as collateral for obtaining bank loans.
 

Investors should remember that while tax-saving fixed deposits offer benefits in reducing taxable income, they come with limited liquidity due to the lock-in period. 
 

Therefore, individuals should carefully assess their financial goals and liquidity needs before committing to these deposits. Seeking advice from a financial advisor is advisable to make an informed decision tailored to one's unique financial circumstances.
 

Now, let’s get into the tax-saving fixed deposit account advantages and disadvantages. 

Advantages (Pros) of Tax Saving Fixed Deposits

Tax-saving fixed deposits offer several advantages that make them an attractive investment option for individuals looking to save on taxes while earning a fixed return on their investment. 
 

Here are some key advantages:
 

  • Tax Deduction under Section 80C

    One of the most significant advantages of tax-saving fixed deposits is the tax benefit they provide under Section 80C of the Income Tax Act. Investors can claim a deduction of up to ₹1.5 lakh from their taxable income in a financial year by investing in these deposits. 
     

    This reduces their taxable income, lowering the tax they must pay. This deduction limit of ₹1.5 lakh encompasses various eligible investments like PPF, EPF, NSC, ELSS, and more.

  • Stable Returns

    Tax-saving fixed deposits offer a predetermined interest rate that remains constant throughout the deposit's tenure. This gives investors a sense of stability and predictability regarding the returns they will earn on their investments. 
     

    This particularly appeals to risk-averse investors who prefer a fixed return over the potentially higher but uncertain returns offered by market-linked2 investments.

  • Safety and Security

    Established banks and financial institutions regulated by the Reserve Bank of India (RBI) offer these fixed deposits. This provides a high level of safety and security for the invested capital. 
     

    In the rare event of a bank defaulting, the Deposit Insurance and Credit Guarantee Corporation (DICGC) covers deposits up to ₹5 lakh, offering an additional layer of protection.

  • Easy Application Process

    Applying for a tax-saving fixed deposit is a straightforward process. Investors can visit the nearest bank or financial institution branch offering these deposits, submit the required documents, and complete the necessary formalities. 
     

    Many banks also offer the option to apply for tax-saving fixed deposits online, making the process even more convenient.

  • No Market Volatility

    Unlike investments in stocks or mutual funds, tax-saving fixed deposits are not subject to market fluctuations2. The returns are not dependent on the stock market's performance or economic conditions. This makes them a reliable option for individuals who want to shield their investments from market volatility.

  • Discourages Premature Withdrawals

    The mandatory lock-in period of five years for tax-saving fixed deposits discourages premature withdrawals. This encourages a disciplined approach to long-term savings, ensuring that investors commit to their investment for the specified duration.

  • Flexible Interest Payout Options

    Investors have the flexibility to choose between different interest payout options. Depending on their financial requirements and preferences, they can opt for monthly, quarterly, half-yearly, or annual interest payments.

  • Loan Against Fixed Deposit

    While premature withdrawals are prohibited, investors can take a loan against their tax-saving fixed deposit. This can be valuable in urgent financial needs, allowing individuals to access funds without breaking the deposit.

Disadvantages (Cons) of Tax-Saving Fixed Deposits 

While tax-saving fixed deposits offer several advantages, it is essential to also consider their potential disadvantages before making an investment decision. 
 

Here are some of the key disadvantages of tax-saving fixed deposits:
 

  • Lock-In Period

    One of the most significant drawbacks of tax-saving fixed deposits is the mandatory lock-in period of five years. During this period, investors cannot access the funds, even in case of urgent financial needs. 
     

    This lack of liquidity can be a significant drawback for individuals who may require access to their funds in unforeseen circumstances.

  • Limited Flexibility

    Unlike other investments like mutual funds or stocks, tax-saving fixed deposits do not provide flexibility in altering or adjusting the investment once it is made. Once the deposit is initiated, the terms and conditions, including the interest rate and tenure, are fixed. 
     

    This lack of flexibility can be a disadvantage if an investor's financial situation changes or if they find more attractive investment opportunities elsewhere.

  • Interest Taxation

    While the interest earned on tax-saving fixed deposits is taxable, the interest is calculated on a cumulative basis and not on a regular payout basis. This means investors do not receive periodic interest payments but instead earn interest reinvested with the principal amount. 
     

    While this can be an advantage for compounding, it can also result in higher tax liabilities, especially for individuals in higher tax brackets.

  • Fixed Returns

    Tax-saving fixed deposits offer a fixed interest rate for the entire tenure, regardless of changes in market interest rates. 
     

    If market interest rates rise significantly after the deposit is made, the investor may miss out on potentially higher returns in other investment options.

  • Inflation Impact

    One of the downsides of fixed returns is that they may not always keep pace with inflation and the investor's real return (adjusted for inflation) may be lower than expected.

  • Tax Implications on Maturity

    When the tax-saving fixed deposit matures after the five-year lock-in period, the interest earned is added to the investor's income for that year and taxed at their applicable income tax rate. Depending on the individual's tax bracket, this could result in a significant tax liability.

  • No Partial Withdrawals or Premature Closure

    Unlike regular fixed deposits, tax-saving fixed deposits do not allow partial withdrawals or premature closure. This can be a significant drawback if an investor faces a sudden financial emergency or needs access to a portion of their funds before maturity.

  • No Capital Appreciation

    Tax-saving fixed deposits do not offer capital appreciation opportunities. Unlike investments in equities or mutual funds, where the value of the investment can grow over time, the principal amount in a tax-saving fixed deposit remains constant throughout the tenure.

Who Should Invest in Tax-Saving Fixed Deposits?

Tax-saving fixed deposits are a suitable investment option for specific categories of investors. 
 

Here are the types of individuals who might benefit from investing in tax-saving fixed deposits:
 

  • Risk-Averse Investors

    Tax-saving fixed deposits are ideal for those who prioritise capital preservation and are averse to taking risks with their investments. The fixed returns and the assurance of capital safety make them a favoured choice among conservative investors.

  • Individuals Seeking Tax Benefits

    Those looking to reduce their taxable income can benefit from tax-saving fixed deposits. These deposits offer deductions under Section 80C of the Income Tax Act, allowing individuals to save on taxes by investing up to ₹1.5 lakh in a financial year.

  • Salaried Individuals with Stable Incomes

    Salaried individuals with a stable monthly income often find tax-saving fixed deposits appealing. These deposits provide a reliable and predictable source of interest income, which can complement their regular salary.

  • Those with Short to Medium-Term Financial Goals

    Individuals with financial goals that align with the five-year lock-in period of tax-saving fixed deposits may find them suitable. This could include goals like saving for a down payment on a house, funding higher education, or planning for a major purchase.

  • Retirees and Senior Citizens

    Retirees and senior citizens often prefer investments with stable returns and low risk. Tax-saving fixed deposits can provide a regular source of income during their retirement years, supplementing their pension or other retirement savings.

  • Individuals Seeking Diversification

    While not typically used as a primary diversification tool, tax-saving fixed deposits can help you bring diversification to your investment portfolio by bringing stability and balance to a portfolio that may include riskier assets like equities or real estate.

  • Individuals with Emergency Fund Requirements

    For some, tax-saving fixed deposits can be a component of their emergency fund. While the lock-in period restricts access, it can benefit those who can set aside a portion of their savings for a longer-term emergency fund.

  • People Who Can Tolerate Lower Liquidity

    Those with sufficient liquidity from other sources who can afford to lock in a portion of their funds for five years may find tax-saving fixed deposits suitable. It is important to ensure that other short-term liquidity needs are adequately addressed before considering this option.

Conclusion

Tax-saving fixed deposits offer a stable avenue for individuals to save on taxes while ensuring the safety of their investments. With a five-year lock-in period and the benefit of Section 80C deductions, they cater to risk-averse investors and those with future financial goals. 
 

However, limited liquidity and fixed returns are factors to consider. Assessing individual financial circumstances and goals before committing to these deposits is crucial. For a well-rounded investment strategy, diversification across different asset classes is recommended.

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Tata AIA Life Insurance

A joint venture between Tata Sons Pvt. Ltd. and AIA Group Ltd. (AIA),  Tata AIA Life Insurance  is one of the leading life insurance providers in India. We post everything you need to know about life insurance, tax savings and a variety of lateral topics such as savings and investments in this space. You can access and read a host of different blogs, articles and pages at the Tata AIA Life Insurance Knowledge Center or get in touch with us with any queries or questions!

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FAQs

Can I withdraw my investment from a tax-saving fixed deposit before the five-year lock-in period expires?

No, tax-saving fixed deposits have a mandatory lock-in period of five years. Premature withdrawals are not allowed, ensuring that investors commit to the investment for the specified duration.

Can I invest in more than one tax-saving fixed deposit?

Yes, you can invest in multiple tax-saving fixed deposit schemes. It is advisable to plan your investments in accordance with your current and future financial requirements and goals.

Are tax-saving fixed deposits suitable for long-term financial goals?

Tax-saving fixed deposits are best suited for short to medium-term financial goals that align with the five-year lock-in period. Other investment options with potentially higher returns may be more suitable for long-term goals. Assessing individual goals and risk tolerance before committing to any investment is important.

Disclaimer

  • Insurance cover is available under the product.

  • The products are underwritten by Tata AIA Life Insurance Company Ltd.

  • The plans are not a guaranteed issuance plan, and it will be subject to Company’s underwriting and acceptance.

  • For more details on risk factors, terms and conditions please read sales brochure carefully before concluding a sale.

  • This blog is for information and illustrative purposes only and does not purport to any financial or investment services and do not offer or form part of any offer or recommendation. The information is not and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.

  • Please know the associated risks and the applicable charges, from your Insurance agent or the Intermediary or policy document issued by the insurance company.

  • Every effort is made to ensure that all information contained in this blog is accurate at the date of publication, however, the Tata AIA Life shall not have any liability for any damages of any kind (including but not limited to errors and omissions) whatsoever relating to this material.

  • 2Market-linked returns are subject to market risks and terms & conditions of the product. The assumed rate of returns or illustrated amount may not be guaranteed and depends on market fluctuations.