Monday, January 29

NSC vs 5-year bank FD: Which is a better tax-saving investment?

Section 80C of the Income Tax Act has a list of specified investment avenues for an individual which ranges from pension schemes, Equity Linked Savings Scheme (ELSS), life insurance to debt oriented products such National Savings Certificates (NSC), Provident Fund (PF), tax saving fixed deposits with banks or post office etc. If an individual invests in these avenues, then up to Rs 1.5 lakh of these investments (along with expenditures eligible under this section) is currently deductible from gross total income thereby reducing the tax payable by the individual. 

If an investor is not comfortable in taking risk by investing in ELSS schemes and wants better returns than life insurance schemes are offering, then he is left with debt-oriented products to choose from. 


Public Provident Fund (PPF), Employees' Provident Fund (EPF), NSC and tax-saving FDs are some of the most widely used debt-oriented options to save tax but the lock-in period of some of these schemes is very long. EPF has a lock-in till the age of 55 whereas PPF has a lock in period of 15 years. On the other hand, both NSC and tax-saving FDs have a lock-in period of five years. Therefore, if a person is looking for short-term debt investments which offer Section 80C tax benefits and also a high degree of safety then he/she is left with these two options. 
* ( Post Office TD Lock in period is 6 month -Refer SB Order 09/2015 )

NSC and tax-saving FDs have certain common features. However, there are certain differences between the two which, interest rate being same or close, give an advantage to NSCs over tax-saving FDs. 

  • Re-investment of interest in NSC is eligible for benefit under Section 80C

As per the current tax laws, interest earned on the NSC and tax-saving FD (cumulative or non-cumulative) are both taxable in the hands of the investor under the head 'Income from other Sources'. However, the interest earned on the NSC is not paid out to the investor, instead it is re-invested and this re-invested interest is eligible for tax benefit under section 80C. 


In the case of the cumulative option of the fixed deposit (which is comparable to NSC), the interest earned and re-invested is not eligible for tax benefit under section 80C. 


"To avail the benefit of interest re-invested in NSC, an individual first has to show the interest accrued as income from other sources and then claim the 80C deduction for the same amount under the overall limit of Rs 1.5 lakh," says, Abhishek Soni, CEO of tax-filing website, tax2win.in 


Soni adds that only the interest accrued for four years qualifies for this deduction. The interest accrued in the fifth year is not eligible for deduction as it gets paid to the investor along with the maturity amount. 


COMMON FEATURES 



Interest rate differential

NSC interest rates are announced by the central government every quarter whereas the interest rates on tax-saving FDs are decided by banks. 


Currently for the quarter running from January to March, 2018, the central government has fixed interest rate of 7.6 per cent per annum, compounding annually, for NSCs. On the other hand, interest rate offered by banks on 5-year tax-saving FDs is currently ranges between 6.00 per cent and 6.50 per cent per annum, compounding quarterly. Senior citizens are offered slightly higher interest rate on bank FDs. 


However, one should not go by the interest rates alone as the frequency of compounding also plays a major role while determining how much money you will earn at the time of maturity. Higher compounding frequency can earn you higher interest. 


A bank tax-saving FD offering interest rate of 6 per cent per annum, compounded quarterly, earns you effective annualised rate of 6.13 per cent and FD offering interest rate of 6.5 per cent a year compounded quarterly gives you effective annualised interest of 6.66 per cent. However, due to annual compounding the effective yield on NSC remains the same as the nominal interest. 


DIFFERENCES 


  • No deduction of TDS on NSC interest
According to the NSC (Viii issue) 1989 rules, interest earned on the NSC certificates is not subject to TDS. On the other hand, interest earned on a bank tax-saving FD is subject to TDS. The TDS is deducted at the rate of 10 per cent in case interest accrued or paid out exceeds Rs 10,000 in a financial year. The limit of Rs 10,000 is set for each bank and not on each branch. If the PAN of an investor is not available, then the TDS will be deducted at 20 per cent, adds Soni. 


To get the refund of higher TDS deduction, a person has to file income tax returns even if the total income is less than the maximum tax-exempted limits. However, a person can submit Form 15G (Form 15H for senior citizens) to avoid TDS deduction. 


TDS deduction also affects how much interest you will receive in the future when the interest accrued is re-invested. Say you have invested Rs 1.5 lakh with a bank FD and NSC. In case of bank fixed deposit because TDS is deducted from your interest first and then the balance interest is reinvested, the maturity value at the end of 5 years is approximately Rs 1.98 lakh whereas for the same time period because of no deduction of TDS and higher interest rate, the NSC's maturity value would be Rs 2.16 lakh. 



If NSC gave the same rate of interest as bank tax-saving FD then, too, the NSC would fetch you a slightly higher maturity amount because TDS is not deducted. Just to compare, even if we assume there is no TDS deduction in a bank FD, NSC's maturity value is higher due to the current interest rate differential. 



Liquidity facility

Another feature that makes NSC score over tax saving fixed deposit is the liquidity. According to the Bank Term Deposit Scheme, 2006 rules, the tax saving FD cannot be used as security to obtain a loan. However, National Savings Certificates (VIII issue) Rules, 1989, allow the certificates to be used as a security to obtain loans from the specified entities. 


According to the rules, the specified entities are as follows: 
a) The President of India or Governor of a State in his official capacity; 
b) The Reserve Bank of India or a scheduled bank or a co-operative society including a co-operative bank 
c) A corporation or a government company 
d) A local authority; and 
e) A housing finance approved by the National Housing Bank and notified by the Central Government. 


Conclusion 
As per current interest rates offered by both instruments, NSC has an edge over bank tax-saving FD as it not only offers higher interest rate but also gives an option to borrow against the certificates in case of a requirement. However, it needs to be mentioned that NSC has this edge mainly because of the interest rate differential that currently exists. 


Further, one must also remember that the interest earned on the NSC certificates and cumulative bank FD will be accrued but not paid out. Therefore, you should consider investing in either of these two only if your expenses can be well managed without a regular interest payout. In addition to that, you must be able to claim the 80C tax benefit for the interest accrued and reinvested in case of NSCs or else it will taxed as per your tax slabs applicable to you. 

By 
Preeti Motiani
Source:- The Economic Times
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