What is a Tax Saving Fixed Deposit? A Complete Guide

A term deposit account which allows investors to claim deduction along with providing long-term investment safety is known as tax-saving fixed deposit. These types of fixed deposit accounts have a specific lock-in period of 5 years. Therefore, they are also popular as a ‘5-year fixed deposit’.

Tax-saving fixed deposits are potential alternatives for investors willing to focus on the security of their investment without market exposure. Investors can claim an income tax deduction through a tax-saving fixed deposit. Explore more about the instrument, evaluate it holistically and understand the tax deduction in detail. 

What is a Tax-Saving Fixed Deposit?

A fixed deposit account offering the facility to claim deductions under Section 80C of the Income Tax Act, 1961, is known as a tax-saving fixed deposit. This type of term deposit is an attractive investment in terms of safety, deduction and long-term investment approach. 

These deposit accounts have a fixed lock-in period of 5 years. The other features of a tax-saving fixed deposit are the same as regular fixed deposits. Tax-saving fixed deposit accounts can have maturity up to 10 years. It can be a suitable investment with a long-term approach to compound the returns.

How Does it Work?

Similar to other deposits, a tax-saving fixed deposit collects investment income from the account holder and compounds its returns over the maturity period. Here is the detailed process:

1. Investors can complete the ‘Know Your Customer’ (KYC) process and open a fixed deposit account.
2. Based on the maturity period and interest frequency, interest compounds over the period.
3. After a minimum period of 5 years, investors can withdraw their investments before the decided maturity.
4. This income, up to ₹1.5 lakhs, can become a deduction under Section 80C. The remaining amount above ₹1.5 lakhs will be added to other incomes to be taxed as per the income tax slab.
5. However, tax will be deducted by the institution before transferring the interest amount. As of January 2025, Tax Deducted from Source (TDS) is 10% on interest as follows:

• Regular investors: Interest above ₹40,000 
• Senior citizen investor: Interest above ₹50,000

Benefits and Drawbacks of Tax-Saving Fixed Deposit

Investors should evaluate the positive and negative side of an investment before deciding its suitability.

Benefits	Drawbacks
Due to its lock-in period, sufficient time is given for investment to grow through compounding.	Its interest may not match market returns. Therefore, inflation may outpace the FD returns.
Investment in the bank FD accounts can be considered secure, as deposits up to ₹5 lakhs are insured.	Investors cannot withdraw the investment before 5 years as it is the mandatory lock-in period.
Income tax deduction up to ₹1.5 lakhs.	Interest above ₹40,000 will be taxable.
A wide range of options with different interest rates and from different issuers are available for investment.	Pre-mature withdrawal may cost investors the interest for the rest period up to maturity.

Investing in these FDs may not be suitable for all types of investors. Therefore, investors can allocate a part of their investment rather than locking a large part of their investment.

Consider this Before Opting for Tax-Saving Fixed Deposit

Investors should also check their suitability with the investment rather than opting for it only for the deduction purpose as it locks the investment for 5 years. Here are some brief points to consider before selecting the investment:

• Compare the different available tax-saving fixed deposit products from different issuers.
• Evaluate the current asset allocation and nature of the portfolio. Moreover, investors should also check their investment objectives. If the purpose is short-term, the 5-year lock-in may not be suitable.
• Calculate the potential tax implication at the end of maturity and check whether the deduction can be claimed.
• Invest in tax-saving fixed deposits for diversification and capital preservation. It may not be feasible for all types of investors to allocate a significant part of their portfolio as the fixed deposit interest rate can be low.

Conclusion

The tax-saving fixed deposit is a term deposit account that allows investors to claim income tax deductions under section 80C. It can be a potential avenue for investors with a potentially long-term financial objective. However, this instrument is charged 10% TDS if it exceeds the threshold of ₹40,000. Investors can calculate their potential income tax deductions to decide their investment.

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