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Avoid tax-saver fixed deposits

Avoid tax-saver fixed deposits

So many of us make the mistake of picking the wrong schemes while making investments for a tax deduction under section 80C. Here’s why to avoid investing in tax-saver FDs.

If you don’t understand the basics of finance, investing can be confusing. This is why so many of us take the easy way out. When it comes to investing, the bank FD is the easiest transaction there is. You just fill in a form, sign it and you’re out. It is, however, a poor investment because you are underutilising the benefit given to you under Section 80C. Here’s why:

Returns are taxable
A bank FD falls under exempt-exempt-taxable (EET), which means that returns on your investment are fully taxable. So let’s say you are in the 30% tax bracket and have invested Rs1 lakh in a 5-year bank FD at a return of 9.5%. At the end of 5 years, the investment would yield Rs1.57 lakh, but what you would receive after tax is Rs1.4 lakh. So while you think you’re getting a return of 9.5%, what you earn is actually a bit under 8%.

So what’s the benefit?
The only real benefit of investing in a 5-year FD is that you get a deduction on the amount you invest. So let’s say your taxable income is Rs11 lakh. At the current tax slabs, you would, therefore, have to pay tax of Rs30,000 on income between Rs2 lakh and Rs5 lakh, Rs1 lakh on income between Rs5 lakh and Rs10 lakh and, in this case, Rs30,000 on the final Rs1 lakh you’ve earned. Therefore, by investing in a 5-year bank FD, you are lowering your taxable income to Rs10 lakh, effectively lowering your tax liability by Rs30,000.

Why PPF is much better
PPF falls under the exempt-exempt-exempt (EEE) regime, which means that it is completely tax free. So whatever you invest in the PPF scheme is out of the reach of the tax authorities. Now, how much better is this scheme than the 5-year bank FD? If you were to invest Rs1 lakh in PPF instead, you would not only lower your tax liability by Rs30,000, any returns you earn would also be free from taxation. Therefore, at the current rate of 8.7%, after five years, you would have earned Rs1.52 lakh. Comparatively, you would have earned just Rs1.4 lakh with the 5-year bank FD, a difference of Rs12,000.

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