If you are planning on investing ₹1.5 Lakh for Tax Savings under Section 80 of the Income Tax Act and thinking whether you should invest your money in NSC (National Savings Certificate, part of Post Office Small Savings Scheme) or in Tax Saver Fixed Deposit Scheme with Banks, then this blog may give you some insights.
In order to make a comparison, we will have to make some assumptions like the amount being invested, the rate of interest and the duration of investment – all should be equal.
Getting Started
Section 80C is much sought after for people who want to save taxes by making investment in tax saving instruments such as NSC, PPF, 5 Years Tax Saver FD, LIC Insurance policy and such.
Let’s start with an assumption that you are going to make an investment based on the following parameters –
Investment Amount = ₹1,50,000
Investment Duration = 5 Years
Rate of Return = 7%
(Please the note that the current rate of return may be more or less than the above and 7% has been chosen to demonstrate, how interest calculation takes place in both of these scenarios).
We can see above that all parameters being same, an extra amount of ₹1,834 gets generated in case of Tax Saver FD’s. Let’s now understand the reason for that and find whether there are any more differences as well.
Interest Calculation of NSC (National Savings Certificate)
In case of NSC, the interest is calculated on an annual basis and then added to the previous year’s balance. For the next year, the interest is calculated on the original amount + interest from previous year, thereby giving it a compounding effect. The interest compounding frequency in case of NSC is annual (this is important as we shall see in the case of Tax Saver FD). So, for an amount deposited for the period of 5 years, the year-by-year calculation looks like below:
For the year 1, the interest amount is ₹10,500 calculated at 7% on ₹1,50,000
For the year 2, the interest amount is ₹11,235 calculated at 7% on ₹1,60,500 (₹1,50,000 + ₹10,500)
.
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For the year 5, the interest amount is ₹13,763 calculated at 7% on ₹1,96,619 (₹1,50,000 + ₹10,500+₹11,235+₹12,021+₹12,863).
As the interest amount keeps on increasing every year, we can clearly see the power of compounding at work here.
Thus, the cashflow in case of an investment in NSC looks something like below:
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Interest Calculation of Tax Saver FD (Fixed Deposit)
In case of a Tax Saver FD, the interest calculation happens very differently. In this case the interest is calculated on a quarterly basis and then added to the previous quarter’s balance. For the next quarter, the interest is calculated on the original amount + interest from previous quarter, thereby giving it a compounding effect – much larger as compared to NSC. The same happens for the entire duration of the Fixed Deposit. The interest compounding frequency in case of Tax Saver FD is quarterly and we can now see why this is important when we are making a comparison with NSC). So, for an amount deposited for the period of 5 years, the year-by-year calculation looks like below:
For the quarter 1, the interest amount is ₹2,625 calculated at 7% on ₹1,50,000 (₹1,50,000*(7%/4))
For the quarter 2, the interest amount is ₹2,671 calculated at 7% on ₹1,52,625 ((₹1,50,000 + ₹2,625)*(7%/4))
.
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For the year 20, the interest amount is ₹3,650 calculated at 7% on ₹2,08,567.
As we can see, since the interest compounding frequency is Quarterly, the total interest generated for 1 year is higher in case of tax saver FD as compared to NSC. This also results in an overall higher interest being generated thus making it a better choice than NSC (if interest rates are equal).
The cashflow in case of an investment in Tax Saver FD looks something like below:
You will also observe that the XIRR in case of Tax Saver FD is 7.18% as compared to 7.00% in case of NSC.
But before you rush to invest in Tax Saver FD, there are some more things to consider.
NSC vs Tax Saver FD – Finer Aspects
One major difference between NSC and Tax Saver FD is how the interest earned on them is treated. In case of Tax Saver FD’s, the interest earned is given on maturity and the tax is applicable on the same as per the applicant’s Tax slab. However, in case of NSC, the interest earned at the end of year can be treated as an additional investment for next year (as part of 80C limit) while the taxation on the same is similar to that of Tax Saver FD.
Minimum and Maximum Amount Limit
In case of NSC, the minimum deposit amount can be of ₹1000 and for maximum deposit, there is no limit.
In case of Tax Saver FD, the minimum deposit amount varies from bank to bank but can start at ₹100 and maximum deposit can be of ₹1,50,000.
Interest Rates
Typically, the Interest Rates for NSC are either more or less than that of Tax Saver FD. But since the interest rates for NSC are revised only on quarterly basis, there may be occasions (like towards end of 2022) wherein Bank’s Tax Saver FDs offer a higher interest rate. Once an investment is made in any of these instruments, the interest rate gets locked for the duration of the deposit.
Premature Withdrawal
Both NSC and Tax Saver FD’s cannot be prematurely closed before 5 years except in certain exceptional scenarios.
In case of normal Fixed deposits, you can break the fixed deposit prematurely. But make sure that in such cases you have used my special FD Premature Withdrawal Penalty and Renewal Calculator(for cumulative deposits) to check how much benefit you will be getting by converting your old Fixed Deposit into new. In case you have non cumulative deposits FD, then you can make use of this calculator instead. Also, make sure you have checked whether you will have to pay the penalty or if you can avoid it.
Which investment instrument do you think is best? Let me know in the comments below.