Most Indians invest with two purposes in mind: build wealth for the future and save on the income tax liability. A fixed deposit is one of the most popular instruments for the first purpose – it keeps your capital safe while also guaranteeing a healthy return on investment. A variation of fixed deposit is tax-saving FD which earns tax-exemption under section 80C of the Income Tax Act. Let us look at the key ways these products differ.
A normal fixed deposit can have a tenure ranging from as low as 7 days to as high as 15 years. A tax-saving FD, on the other hand, has a tenure of five years. Further, the principal amount invested in a tax-saving fixed deposit has to be at least ₹1 lakh. You can make a normal fixed deposit for an amount as low as ₹1,000.
In a normal fixed deposit, you can choose to have the interest paid out at a regular interval. This interval can be monthly, quarterly, half-yearly or annual. You can also opt for the interest to be added back to the deposit annually. A tax-saving fixed deposit does not make token payments. All the accrued interest is to be collected at maturity along with the principal.
Most normal fixed deposits have short lock-in periods. They can range from no lock-in to 3 months. A tax-saving fixed deposit has a lock-in period of 5 years. This makes the later much more illiquid and you should invest in them only if you are sure of your liquidity requirements.
After the lock-in period, if any, for a normal fixed deposit has elapsed – the depositor can make a premature withdrawal. As a penalty, the applicable interest will be lowered by a fixed percentage, typically 1% per annum. Premature or partial withdrawal is not allowed from a tax-saving fixed deposit.
Loan against fixed deposit
You can avail of a loan of up to 75% of the principal value against most normal fixed deposits. This facility is not available for tax-saving fixed deposits – further reducing the liquidity compared to normal deposits.
The amount invested in a tax-saving fixed deposit can be claimed as a deductible under Section 80C of the Income Tax Act. The interest earned attracts a tax based on your overall income bracket. No such deduction can be claimed on a normal fixed deposit.
While each type of fixed deposit offers its own set of advantages, the flexibility provided by a normal fixed deposit is more attractive for most investors. A tax-saving fixed deposit is only useful if your deductible under Section 80C has not yet reached the allowed limit of ₹1.5 lakh. The tax-saving fixed deposit has the lowest lock-in period among the investment options available under Section 80C. That said, a normal fixed deposit is much more liquid and can be used in case of an emergency or when you are short of funds for any reason. It can also be used to generate a fixed income from the corpus you have built up over the years.