With the last quarter of the financial year upon us, tax-saving instruments are back in focus. With the popular section 80C already crowded with multiple options such as PPF, EPF, life insurance, ELSS etc. are 5-year deposits still attractive? Read on for more.

Strings attached

The tax saver deposit scheme comes with certain conditions to be complied with that act as dampeners. First, a 5-year lock-in period applies on these deposits. The account once opened cannot be closed before the end of five years. However, if a taxpayer does so, the amount of deduction under section 80C (to the extent it pertains to the deposit) claimed in the year in which the account was opened, will be included in the income of the financial year in which the account is prematurely closed. This implies that only funds that do not have an end use in the short to medium term only can be deposited in this scheme.

Let’s assume the case of a taxpayer who invests ₹1.5 lakh in tax saver deposits every financial year and claims 80C deduction. The account opened in the first year will mature in the sixth financial year and the same will be renewed for another five years (to claim 80C in the 6th FY), creating a loop that will never end unless she finds another way of claiming the 80C deduction such as PPF or ELSS mutual funds (equity linked savings scheme) or chooses to file returns under the new regime.

Lacklustre returns

Returns are not great either. This is despite the fact that we are at the peak of the interest rate cycle, allowing investors to lock higher interest rates for longer. But banks are offering interest rates higher than that offered for tax saver deposits for much shorter tenors now. However, India Post is an exception. Among the interest rates offered by India Post for various tenors, it is the 5-year deposit that carries the highest rate at 7.5 per cent.

The interest earned isn’t tax-free either, as in the case of PPF, for instance. Therefore, post-tax returns can go as low as 5.25 per cent (at an interest of 7.5 per cent and tax rate of 30 per cent), depending on the tax slab of the assessee. In the case that funds once invested in tax saver deposits remain invested in a loop, investors with a moderate risk appetite can be better off investing in ELSS funds that largely invest in relatively stable large-cap stocks and yield higher returns. Such taxpayers also get to enjoy the lower capital gain taxation of 12.5 per cent on redemption of units of such ELSS funds.

Why new regime makes more sense

The government has been championing the push towards the deduction-less new regime for a while now, while also making it a lot attractive relative to the old regime. Reports suggest that about 70 per cent of the taxpayers have filed returns under the new regime in FY24.

The accompanying infographic compares the new regime with the old regime across income ranges. An individual under the age of 60, earning income from salary only, under the old regime, is assumed to claim deduction only under section 80C, against an investment of ₹1,50,000 in a tax saver deposit. It is quite clear from the infographic that the new regime is far better than the old regime across income levels.

However, taxpayers willing to continue under the old regime can consider opening tax saver deposits with small finance banks (SFBs). While offering higher interest rates of up to 8.25 per cent (Suryoday SFB), deposits with SFBs also carry DICGC insurance cover up to ₹5 lakh.

In our view, overall asset allocation and goal-based investing must be prioritised over just tax-saving. Investments work best when aligned with specific goals.

Key points
Conditions make it not a big draw
Interest earned isn’t tax free
New regime fares better across income levels

Published on January 3, 2025