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

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

, ET Online|
Updated: Jan 03, 2019, 09.51 AM IST
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TDS deduction also affects how much interest you will receive in the future when the interest accrued is re-invested.
Section 80C of the Income Tax Act has a list of specified investment products using which people can save up to Rs 1.5 lakh in tax in a financial year. These include pension schemes, Equity Linked Savings Scheme (ELSS), life insurance to debt oriented products such National Savings Certificates (NSC), provident fund (PF), and tax saving fixed deposits (FD) with banks or post office.

Debt-oriented options like NSC, PPF, EPF, and tax-saving FDs are consider safer but are not liquid. 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, some with a shorter time horizon can consider these.

Here is a look at how NSC and bank tax-saving FDs stack up against each other as tax-saving investments.

  • Re-investment of interest in NSC is eligible for benefit under Section 80C
As per the current tax laws, interest earned on 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 interest amount is 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.

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

COMMON FEATURES of NSC and TAX-SAVING FD
Lock-in period Five years
Tax benefit Investment qualifies for tax break under section 80C up to Rs 1.5 lakh
Income earned is fixed Interest rates are locked for duration of investment and are not subject to volatility
Tax on interest earned Interest earned is taxable under the head 'Income from other sources'
Maximum Investment limit There is no limit on the maximum amount for investment

  • Interest rate differential
NSC interest rates are subject to revision every quarter by the central government whereas the interest rates on bank tax-saving FDs are decided by banks. Interest rates of bank FDs are periodically changed by depending on various factors.

Interest rates: Currently for the quarter running from October to December, 2018, NSC is offering interest rate of 8 per cent per annum, compounding annually. Interest rate on 5 year tax-saving FDs of SBI and HDFC Bank is 6.85 per cent and 7.25 per cent, respectively. IDFC Bank is offering 8.25 per cent on its tax-saving FDs with quarterly compounding.

Most banks offer higher interest rates on FDs to senior citizens. Usually banks offer additional 0.50 per cent to senior citizens. Currently, SBI is offering 7.35 per cent, HDFC Bank 7.75 per cent and IDFC is offering 8.75 per cent. On the other hand, NSC offers the same rate to all investors irrespective of age.

However, one should not go by the interest rates alone as the frequency of compounding and tax deducted at source (TDS) 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.

Compounding frequency: SBI tax-saving FD with 6.85 per cent, compounded quarterly, will earn effective annualised rate of 7.02 per cent whereas, HDFC Bank's FD will fetch an annualised rate of 7.45 per cent. IDFC bank tax-saving which is currently offering higher interest rate than NSC will fetch effective yield of 8.50 per cent. NSC, on the other hand, offers annual compounding therefore, effective interest rate remains the same at 8 per cent.

DIFFERENCE BETWEEN NSC and TAX-SAVING FD
Features NATIONAL SAVINGS CERTIFICATES TAX-SAVING FIXED DEPOSITS
TDS deduction No TDS deduction TDS is deducted
Liquidity Can be used as collateral for loan Cannot be used as collateral for loan
Compounding frequency Annually Quarterly (Generally)
Interest rate 8% for the quarter Oct-Dec, 2018 SBI - 6.85%
HDFC Bank & ICICI Bank - 7.25%
IDFC Bank - 8.25%
*Interest on bank FDs as published on bank's website on Nov 20, 2018.

  • No deduction of TDS on NSC interest
According to the NSC (Viii Issue) Rules, 1989, 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. In case of bank FD, TDS is first deducted from interest and then balance is re-invested. Given below is a table showing maturity values at the end of five years of tax-saving FD with SBI, IDFC Bank and NSC.
NSC-vs-bankFD
Note
*Value of each year is computed separately to arrive at maturity amount at the end of five years.
*Assumption of TDS deduction in case of interest payments exceeds Rs 10,000.
*TDS is deducted before being re-invested again in case of bank FD.


NSC, in comparison with SBI and IDFC Bank FDs, is offering higher maturity value. After five years, NSC will fetch you Rs 2.20 lakh at maturity whereas, SBI's tax-saving FD will return Rs 2.03 lakh and on IDFC Bank's tax-saver FD you will earn Rs 2.16 lakh.

In case of those who submit Form 15G or 15H to the bank the interest rates and compounding frequency of NSC versus bank FDs will determine which instrument will give the higher interest yield on maturity.
Liquidity

NSC certificates can be used as collateral to obtain loan. However, a bank tax-saving FD cannot be used for the same as per Bank Term Deposit Scheme Rules.

Also Read: How to use NSC to get a loan

What you should do
1. As the above example shows that due to TDS interest amount re-invested on a bank FD may be lower than that of NSC despite the former offering a marginally higher rate. Therefore, when comparing the two instruments for the purpose of tax-saving, you should compare the interest yielded on maturity of both and not just the interest rate.
2. If your income is below the taxable limit and you have submitted Form 15G, then the two instruments would be on par as far as non-deduction of TDS is concerned. In this case you need to only look at the other factors discussed above, i.e., interest rate and compounding frequency etc.
3. If you are a senior citizen and your income is below taxable level then you can avail of higher interest rate as well as non-deduction of TDS by submission of Form 15H. In this case, many of the advantages of NSC may get replicated in the bank FD.

Therefore, you need to consider all the above factors when choosing the correct instrument to invest in. 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 regular interest income from these investments.

Also Read

Tax saving options under section 80C: Features explained

Best tax saving investment for my retired mother

Best tax saving investment for my retired mother

Four commonly-held misconceptions about ELSS or tax saving mutual funds

When should you sell an ELSS or tax saving mutual fund scheme?

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