Both equity-linked savings schemes and long-term FDs help in saving tax. But what is your risk appetite?
Iquity-linked savings schemes (ELSS) help you save tax. But, therefore, make a tax-free fixed deposit (FD). What should you choose?
The answer depends on your risk profile. But, before that, let’s take a look at what each offers, and what is needed. Investments of up to SS 1.5 lakh per financial year in both ELSS and tax-saving FDs are eligible for tax deduction under Section 80C.
ELSS invests mainly in equity. On the other hand, tax-saving FDs are the means of income offered by post offices and banks. Apart from different asset classes, ELSS and tax-saving FDs also differ widely in terms of product features and taxation of returns.
Therefore, a comparison of product features will help investors to make an informed choice between these two tax-saving options.
capital preservation
Tax-saving FDs from post offices and banks score high in terms of capital protection, especially when compared with market-related investment products such as ELSS. Post-office term deposits come with a sovereign guarantee from the Government of India, and banks that are listed as scheduled banks by the RBI are insured up to ₹ 5 lakh under DICGC, a subsidiary of RBI . It covers the cumulative deposits of each depositor in fixed, recurring, current and savings accounts with each scheduled bank up to 5 lakhs in case of bank failure. If you are a low risk investor, then you should know that ELSS funds mainly invest in equities and such investments suffer from the inherent volatility of equity markets.
However, this risk can be mitigated and is, in fact, used to your advantage by investing via SIP mode. SIPs or systematic investment schemes ensure disciplined investment at periodic intervals. It also helps the average cost of the rupee during market correction, eliminating the need for market time.
Rate certainty
Tax-saver FDs pay a fixed rate of interest by the end of the deposit period, regardless of any change in card rates during the inter-period. Thus, they provide unique certainty in terms of rate of return. Currently, the interest rate on the tax saver FD offered by banks is around 4% -7.5% per annum, while currently the 5-year post-deposit deposit offers an interest rate of 6.7% per annum. The return performance generated by ELSS funds depends on their portfolio component.
More Returns?
However, being an equity-oriented scheme, ELSS defeats fixed-income instruments over a longer period of time. In fact, as a category, ELSS generated average annual returns of 9%, 16% and 13% per annum, respectively, over the previous 3-year, 5-year and 10-year periods. Tax saving FDs of banks and post offices come with a lock-in period of 5 years. Depositors may opt for either a reinvestment option – in which the interest component is reinvested by the end of the FD tenure – or to generate regular income, if available, for quarterly or monthly interest payments.
In the case of ELSS funds, the 3-year lock-in period is the shortest of all Section 80C tax-saving investment instruments.
Although it is always advisable to stay invested in ELSS schemes for the long term, the option to redeem only after three years offers investors greater financial flexibility.
ELSS investors can choose to stop or stop their SIP at any time without penalty.
Minimum investment
The minimum investment amount for opening FDs in most banks and post office schemes is 1,000. However, they do not charge consumers for opening or maintaining FDs. In the case of ELSS funds, the minimum investment amount for most fund houses is SS 500.
tax treatment
The interest income generated by the FD is levied as per the applicable tax slab of the depositor. For ELSS, long-term capital gains (LTCG) of more than 1 lakh realized in the financial year derived from equity and equity related instruments such as ELSS and equity mutual funds attract LTCG tax of 10%. ELSS funds provide greater tax efficiency, especially for those in higher tax brackets. In addition, higher equity prospects in the long run allow ELSS funds that are performing well to generate much higher after-tax returns after FDs.
Capital protection and income certainty offered by tax-saving FDs will appeal to those with a conservative risk appetite. ELSS funds will correspond to high risk, high liquidity, tax efficiency and high risk appetite for long term wealth creation.
When choosing an ELSS plan, make sure that you compare the performance of various ELSS funds with their benchmark indices over the past 3-year and 5-year periods. Although past performance does not guarantee the future, comparing funds will help you understand how they deal with different economic conditions and market cycles in the past.
(The author is CEO and co-founder, Paisabazaar.com)
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