The Tax Savings fixed deposit (FD) and the National Savings Certificate (NSC) offer guaranteed interest payments and capital safety for the duration of the program. However, the following guide may help you decide whether of the two is a better tax-saving alternative for you:

The National Savings Certificate: What is it?

A post office savings plan with a fixed income is the National Savings Certificate (NSC). The Indian government is the one providing it. This program requires in-person activation at the post office, and it has a 5-year lock-in period after which the certificate cannot be renewed. For the duration of the plan, the interest rate is fixed. An NSC's current interest rate is 6.8% per year, payable at maturity. Every year, the interest for NSC has increased. Moreover, both the principal and interest paid are eligible for an 80C deduction.

The Income Tax Act of 1961's Section 80C sets a maximum benefit of Rs. 1.5 lakh. In NSC, investing is not a possibility. If one wants to stay in this plan after the tenure ends, they must buy a new certificate.

What is a fixed deposit that saves taxes for five years?

A fixed deposit is a type of financial instrument that allows an investor to deposit money with a bank in one lump sum for a predetermined amount of time at a fixed interest rate. The investment period is seven days to ten years. The invested amount plus interest will be returned to the investor upon maturity. One of these is the tax-saving fixed deposit, which is eligible for a tax deduction under Income Tax Act of 1961 Section 80C. The amount of the deduction is determined by the investment that was made. Thus, by making an investment in a tax-saving FD, investors can save tax up to a maximum of Rs 1,50,000. The tax-saving FD does, however, have a five-year lock-in period.

Furthermore, interest on FDs is taxable at the rate of the corresponding income tax bracket. FDs are automatically renewable. To renew it, one does not have to go to the bank. Furthermore, if the interest income from tax-saving FDs surpasses Rs 40,000 (Rs 50,000 for senior persons), 10% TDS will be deducted from the amount.

Beyond these significant distinctions, Jain says there are a few other things to think about when making your decision, like:

Premature withdrawal: Your money is locked away for five years in both tax-saving FDs and NSCs. While there may occasionally be early withdrawal penalties associated with FDs, NSC investments do not permit any early fund withdrawals. Except in exceptional circumstances, such as an investor's death, you are only permitted to withdraw after the five-year lock-in period.

According to Scripbox, only certain circumstances, such as the certificate holder's death, permit an early withdrawal from an NSC before maturity:

• Regarding the gazetted officer's forfeiture of the certificate as directed by a court of law.

• Retraction from either plan will result in no interest being paid. If investors remove their money too soon, they may be penalized.

Amount of Investment:

NSC: No maximum, a minimum of Rs. 100.

FD: The maximum tax deduction is Rs. 1.5 lakh, while the minimum varies by bank.

NSC: Five-year lock-in period with penalties for early departure.

FD: Usually locked up for five years, but certain banks allow early withdrawals with a fee.

Risk: Because both are guaranteed by the government (NSC) or insured by DICGC (FDs up to Rs. 5 lakh), they are regarded as low-risk investments.

Interest payments: Non-redeemable certificates (NSCs) only provide interest on an annual basis. Interest is reinvested at the conclusion of the fifth year. On the other hand, with options for monthly, quarterly, or annual payouts, FDs provide greater flexibility. Depending on whether you would rather get a big payment at the end or a recurring income, choose the option that best meets your needs.

Earning potential: While income is earned on both options, NSC typically has higher interest rates than FD. On the other hand, FDs often gain a little bit from quarterly compounding, which is more frequent than the annual compounding of NSCs. Over the course of five years, this may result in a higher total yield.

Tax ramifications: Although both NSCs and FDs provide benefits under IT (S) 80C, NSCs allow for the whole interest generated to be claimed as a deduction under Section 80C. Conversely, with FDs, you may only deduct the initial investment amount—not the interest. Both types of interest income are taxable; in NSCs, no TDS is withheld, while in FDs, TDS (tax deducted at source) is imposed if interest income surpasses a specific threshold.If the interest income is more than Rs 40,000 (Rs 50,000 for senior citizens), it is deducted at a rate of 10%.

"The interest earned on NSC and tax saving FDs is taxable in the hands of the investor under the heading ‘Income from Other Sources.’ However, the interest earned on NSC is not paid out to the investor. Instead, it is reinvested and this interest amount is eligible for tax benefit under section 80C. To avail the benefit of interest on NSC, the investor has to first show the interest accrued under Income from other sources and then claim tax deduction under Section 80C within the limit of Rs. 1.5 lakh," explained Scripbox.

Which should you select between NSC and tax-saving FDs?

Investors need to take into account all pertinent criteria while assessing investing possibilities. It's also crucial to remember that interest earned on FDs and NSCs is reinvested rather than being paid out as income. As a result, those who don't need a steady income are most suited for these schemes.

"From a broader perspective, NSCs, due to their lack of liquidity, are better suited for long-term objectives such as retirement planning. On the other hand, FDs offer greater flexibility as they can be prematurely withdrawn when funds are needed urgently," said Adhil Shetty, CEO of Bankbazaar.

In addition, Chakravarthy V, Executive Director and Co-Founder of Prime Wealth Finserv Pvt. Ltd., provides the following example to illustrate this:

Suppose you invest Rs. 1 lakh in both NSC and FD, with a 30% tax bracket.

NSC: 

1. Interest earned after 5 years (compounded annually) = Rs. 39,455.56

2. Tax benefit under Section 80C = Rs. 1 lakh (This already accounts for the interest earned)

3. Effective post-tax return = Rs. 1 lakh + Rs. 39,455.56 = Rs. 1,39,455.56

Fixed Deposit (assuming 7 per cent p.a. interest):

1. Interest earned after 5 years (compounded quarterly) = Rs. 40,578.62

2. Tax on interest income (assuming no TDS deduction) = Rs. 12,173.58 (30 per cent of Rs. 40,578.62)

3. Effective post-tax return = Rs. 1 lakh (investment) + Rs. 40,578.62 (interest) - Rs. 12,173.58 (tax) = Rs 1,28,405.04

4. Based on this calculation, NSC offers a slightly higher effective post-tax return in this scenario

But it's important to take into account additional factors:

Higher FD rates and no TDS are available to seniors, which could make FDs more advantageous.

Needs for liquidity: FDs with early withdrawal features may be a better fit if you anticipate using the money before five years.

According to Chakravarthy, one should select NSC if they wish to:

• Marginally greater potential returns, particularly for non-elderly citizens.

• Reduced risk (supported by the state).

Investing objectives that are long-term, meaning you won't need the money for five years.

The five-year FD is the best option if:

• If there is a possibility of higher interest rates (if you find a bank with an extremely competitive rate or are eligible for senior citizen privileges).

• Greater flexibility, with alternatives for early withdrawal offered by certain banks.

• Needs for shorter-term investments: If you need the money before five years, be prepared to pay penalties.