ELSS V/S Tax Saving FD: Which Is the Best Tax Saving Option?

Published On: 24-Apr-2020

Section 80C of the Income Tax Act provides various investment options to the taxpayers to be eligible for a tax benefit. While many taxpayers prefer tax-saving fixed deposit (FD) due to more natural investment process and guaranteed returns, ELSS (Equity Linked Savings Scheme) has been emerging as a preferred tax saving investment option off late.

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 Let us have a comparison of Tax Saver FD vs ELSS on various investment considerations:

Tax Benefits :

Both, Tax Saver FD and ELSS, are eligible for benefit under Section 80C, equal to the amount so invested in any of the options and subject to the overall ceiling limit of Rs. 1.50 lakh under Section 80C.

Lock-in Period:

While ELSS carries a lock-in period of 3 years from the date of investment, tax saver FD is subject to a lock-in period of 5 years. As such, ELSS scores better in terms of lower lock-in period for the investors, as compared to tax saver FD. ELSS carries the lowest lock-in period amongst all the available investment options under Section 80C.

Risk Appetite:

ELSS invests at least 65% of its net assets in the listed shares of domestic companies. As such, investors who are comfortable with having equity exposure are more likely to invest in ELSS. On the other hand, tax-saving FD is suitable for conservative investors, it being a fixed-income investment product. 

Returns:

The interest on tax saver FD is fixed by the respective banks offering such deposits. The current rates being offered by different banks on such deposits range from 6.00% to 7.50%. However, the rate of interest gets locked at the time of booking such a deposit, and the investor will receive a fixed amount at the maturity of the deposit (subject to tax deduction at source - TDS). 

ELSS provides market-linked returns to the investors since 65% of the underlying portfolio of such schemes is invested in listed equity shares of domestic companies. While the past performance is not a guarantee of future returns, the investors may have a fair idea of the potential of such funds to create wealth through their historical performance. ELSS funds, category average, is -3.78% annualized returns over the last three years (as on 31st March 2020, Source – MFI Explorer).

Taxation:

The interest on tax saver FDs will be taxed at the tax rates as may be applicable to the taxpayer. As such, the taxpayers who are within tax bracket of 30% may have to pay 30% tax on the already low-interest rates. On the other hand, the returns on ELSS funds are taxed as Long-Term Capital Gains (LTCG) since the investors are required to be mandatorily invested for a minimum period of 3 years with such funds due to the lock-in period. As such, LTCG from ELSS funds is taxed at 10% (plus applicable cess and surcharge), but without any benefit of indexation. The investors may also avail an exemption of Rs. 1 lakh a year, for all such gains on equity shares and equity-oriented mutual funds (including ELSS) taken together.

Mandatory Liquidation/ Redemption :

Tax saver FDs are liquidated/ matured after the expiry of the lock-in period of 5 years. If the taxpayer wishes to stay invested, he/ she needs to reinvest such maturity amount as a fresh tax saver FD and such investment will again be subject to the 5-year lock-in period. On the other hand, an ELSS investor enjoys the flexibility to stay invested in such funds, even beyond the expiry of the 3-year lock-in period. One may place a redemption request any time after the initial three-year period to liquidate his/ her ELSS investments. 

The convenience of Investing :

 While it is possible to invest periodically in tax saver FDs, every such investment creates a fresh fixed deposit, upon specific investment action by the taxpayer. On the other hand, to invest in ELSS on a periodical basis, the taxpayer may register a Systematic Investment Plan (SIP), wherein the amount gets deducted automatically from the bank account and gets invested in ELSS. As such, it is much more convenient to invest in ELSS on a staggered basis. 

Since ELSS equips the taxpayer with the potential of wealth creation, coupled with the lowest lock-in period, the taxpayers may prefer investing in ELSS over any other investment options under Section 80C including tax saver FDs. However, the final decision must be made after considering your risk appetite and risk profile. 

Note – The tax provisions, as mentioned in the article, have been updated till the Finance (No. 2) Act 2019 and are only for illustrative purposes. The tax incidence on mutual fund investments is as per the tax laws applicable on the date of redemption. You must consult your tax advisor for detailed tax incidence for your investments.