The new year 2018 is here and so is the time to do tax saving and investments. Let us take a new year resolution to find the best suited tax-saving product before investing in one. In this Batter of Tax-Savers series, we help you do just that. Read on to find how you can save ₹46,350 in taxes and also watch that ₹1.5 lakh investment grow to ₹2.64 lakh in just 5 years!
For many of you working in jobs, you would have got an email from HR seeking investment proofs. If you have little or no clue of what investments to do for that, you have reached the right place! Investing in 80(C) tax saving schemes has been one of the most favorite tax-saving methods. Under this Section 80(C) of the Income Tax Act, individual tax-payers are eligible to get a deduction of up to ₹1.50 lakh of their salary per year if they invest in the prescribed schemes. Some of the popular ones are PPF, ELSS mutual funds, Tax-saving FDs, NSC and ULIP insurance policies.
In this article, we will compare 2 such popular schemes — ELSS mutual funds with Tax-saving FDs. We will see how investing 1.5 lakh in ELSS funds can give you ₹80,000 more returns than tax-saving FDs in 5 years. We will understand the 2 schemes briefly before diving into the comparison.
What is Tax-saving Fixed Deposit (FD)?
Most of us would have heard of bank Fixed Deposits popularly known as FDs. In a fixed deposit, you save your money with a bank for a predetermined period (e.g. — 1 year) at an interest rate fixed (e.g. — 6.25%) at the time of opening. At the time of maturity, the bank pays back the savings amount along with interest. This interest gets added to your annual income and is subject to income tax at your marginal income tax rate (30% for people with incomes above 10 lakh p.a.). The bank also deducts TDS (Tax Deducted at Source) at 10% rate if interest across all your FDs exceeds ₹10,000 in a fiscal year.
Tax-saving FDs are a special category of FDs which have a 5-year lock-in period. Unlike regular FDs, premature withdrawals are NOT allowed from Tax-saving FDs. They qualify as an 80(C) tax-saving instrument and thus investments up to ₹1.5 lakh p.a. are exempt from income tax. However, the interest on these FDs remains taxable at marginal income tax rate. TDS policy also applies. Check out FD rates here.
Mutual Funds are investment schemes professionally managed by financial experts. These investment schemes invest in Shares/Stocks (Equity), Government and Corporate Bonds/ Securities/ Debentures (Fixed Income) or a mixture of the Equity and Fixed Income Securities.
ELSS mutual funds are a special category of mutual funds that offer tax exemption under section 80C. These funds invest a majority of the corpus in equity or equity-linked products and thus offers higher returns than other 80(C) instruments which predominantly invest in fixed-income instruments. That said, actual returns are dependent on the stock market and individual stock holdings in the fund. While the returns are subject to volatility, ELSS funds have historically given much better returns as compared to other traditional 80(C) investment options over the long term.
For example, yearly investment of ₹1,50,000 in Aditya Birla Sun Life Tax Relief 96 since the launch of the fund in March 1996 has generated high annualized returns of 21.60% depicting consistency over the long-term. An overall investment of ₹33 lakh spread over last 22 years has become a whopping ₹5.67 crores as of 30 Oct 2017.
Point-to-Point Comparison of ELSS and Tax Savings FDs
Both ELSS and Tax Savings Fixed Deposits offer tax benefits under section 80C. But the similarity ends there. ELSS typically gives much higher returns on investment as compared to tax-saving FDs in the long term. While FD returns are hovering around 6–6.75% pre-tax and ~4.5% post tax, ELSS gives 12–15% annualized returns (as per historical trend) over the long-term horizon of 7–10 years. Let us go through a case study to illustrate this:
Assume Raj invested ₹1,50,000 in FD for 5 years with 6.00% returns whereas Rashmi invested ₹1,50,000 for 5 years in an ELSS mutual fund. Consider the returns in the following table for both the cases:
As you can see, Rashmi generated more than 3 times the returns with ELSS funds as compared to Raj with FD.
Tax-saving FDs are suitable to a small set of extremely risk-averse or conservative individuals because of low-yet-guaranteed returns. For everybody else, ELSS funds is the clear choice compared to tax-saving FDs for saving income tax under Section 80(C). Sub 5% post-tax FD returns may not be able to even beat inflation which is ~5% now and is only expected to rise. That said, investment in ELSS mutual funds should be ideally done through a monthly SIP (Systematic Investment Plan) to reduce market risk and increase the chances of a higher return. Also, investment in ELSS should be done with a long-term view of 5–10 years so that the dual benefits of compounding and capital appreciation can be reaped in.
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