Tax-Saving Fixed Deposits Vs ELSS
Tax-saving season forces you to make a few choices about investments, something not everyone enjoys. There are many ways to save income tax. Which one should you choose?
I have done detailed posts comparing PPF, ELSS and NPS. In this post, I will compare tax-saving fixed deposits and ELSS.
Tax Saving Fixed Deposit Vs ELSS (Equity Linked Savings Scheme)
Tax-saving 5 year FD is a fixed income product. You know the return upfront. Your money is locked in for 5 years and the interest earned is taxable.
ELSS is a variant of equity mutual funds. Hence, ELSS comes with volatility associated with equity investments. Your investment is locked for 3 years. Any capital gains arising from redemption of ELSS units are exempt from tax.
Here are a few aspects that you must consider.
ELSS and Tax-saving fixed Deposits are very different products. If you need to add equity to your portfolio, ELSS is a better choice.
If you need a fixed income product, tax-saving 5 year Fixed deposit is a better choice.
You also need to see what you need to add to your investment portfolio in overall scheme of financial planning.
Do not fall for lower lock-in
Many proponents of ELSS argue that the ELSS has the lowest lock-in period of 3 years among 80C product basket. The aspect is only partly correct.
Every investment in ELSS is subject to a lock-in of 3 years. In other products such as PPF (15 years) and ULIPs (5 years), the lock-in is counted from the date of first investment. So, if you have a 10 year old PPF account, your fresh investment is locked in for only 5 more years.
Another aspect lock-in period should not be associated with investment horizon. For instance, even though the lock-in period for ELSS is 3 years, it does not mean ELSS are suited for 3 year goals. I have reiterated many times in many of my blog posts that you shouldn’t investing in equity funds if your investment horizon is less than 7 to 10 years.
By the way, there is nothing wrong in staying invested in ELSS for more than 3 years.
What about returns?
Tax-saving FD provides fixed returns. You know upfront how much you will get.
With ELSS, be prepared for volatility. You may even have to redeem at a loss. But yes, the potential for return is high.
What if I you have a PPF account?
If you have a PPF account which is already 10 years old, then the investment you make in PPF account is locked for only another 5 years. In that scenario, the case for investment in 5 year tax saving fixed deposit becomes much weaker.
Interest on Fixed deposit is taxable while the interest on PPF is exempt. PPF is likely to offer better post-tax returns.
By the way, I am not suggesting that you close your PPF account after initial maturity of 15 years. But PPF withdrawals become quite lenient after initial maturity of 15 years.
I am also not suggesting that you prefer PPF over tax-saving FD only if you PPF account is atleast 10 years old. My PPF account is quite new. I still prefer PPF over tax-saving FDs.
Read: PPF vs ELSS
What do I do?
I quite like PPF. Early on, during my professional career, I had made investments in both Tax saving Fixed Deposits and ELSS.
At the time, I did not understand PPF as well and in fact had not even opened a PPF account. Ever since I opened my PPF account, I bridge the deficit after term insurance premium and EPF, if any, by investing in PPF account. To be honest, I don’t mind maxing out my PPF limit even though the Section 80C limit is already exhausted.
Do note I invest heavily (relatively) in equity funds too. That is also a reason I do not invest in ELSS funds.
What should you do?
Take account of the investment that you need to make to exhaust your Section 80C basket. Do note there are many eligible expenses/investments such as EPF, insurance, housing loan repayment, tuition fees, NPS (80CCD(1)) etc under Section 80C.
If you fall in lower income tax slab, you may not even need to exhaust your Section 80C limit. Other deductions/allowance for HRA, housing loan interest payment, health insurance premium etc may have already reduced the tax impact.
Moreover, in a few cases, financial prudence may suggest that you let the Section 80C limit unutilized. For instance, if you need the funds in 6 months, it does not make sense for you to lock in money for 3 to 5 years.
Avoid purchasing fresh traditional life insurance plans. ULIPs, although relatively far better products, can also be avoided.
Between Tax-saving FD and ELSS, consider suitability and overall fit with your investment portfolio. ELSS investment must be for at least 7-10 years.
If you invest in equity funds only through ELSS (many investors do), it may not be bad choice to get equity exposure through ELSS. I assume equity funds fit in overall financial planning. You may also consider planning ELSS investments well in advance and invest through SIP.
If Tax-saving FD is your choice, do consider alternatives such as PPF and Voluntary EPF.
In any case, do not exceed the Section 80C deficit through your investment in ELSS or tax-saving FD i.e. invest only as much as required.
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