Tax Saving FD Vs ELSS: Which option to choose for a lump sum investment? Which one offers better returns?

For investors looking to invest a lump sum, choosing between a Tax Saving FD and ELSS is not easy. While FDs are safe and offer lower returns, ELSS offers the potential for higher returns but comes with market risk. Understanding the differences between the two before investing is crucial.

If you have a lump sum amount and want to grow it while saving on taxes, the biggest question is whether to choose a Tax Saving FD or an ELSS Mutual Fund. Both offer tax benefits under Section 80C of the Income Tax Act, but they differ significantly in terms of returns, risk, and lock-in period. A wrong choice can significantly impact your returns. Here's a comparison to help you decide whether FD or ELSS is better for a lump sum investment, where you can get higher returns, and which option is right for which type of investor.

What is a Tax Saving FD?

A Tax Saving FD (Fixed Deposit) is an investment where you deposit a lump sum for 5 years. The interest rate is fixed, and the investment is considered completely safe.

Key features of Tax Saving FD

• Lock-in period: 5 years
• Tax exemption: Up to ₹1.5 lakh under Section 80C
• Risk: Almost negligible
• Returns: 6% to 7.5% per annum (depending on the bank)
• Tax on interest: Applicable

This option is suitable for those who want to avoid risk and prefer fixed returns.

What is an ELSS Mutual Fund?

ELSS (Equity Linked Saving Scheme) is a mutual fund that invests in the stock market and offers tax-saving opportunities. Investments can be made through both lump sum and SIP (Systematic Investment Plan). Key Features of ELSS

• Lock-in period: 3 years (shortest under Section 80C)
• Tax exemption: Up to ₹1.5 lakh
• Risk: Market-linked
• Potential returns: 10% to 15% or more
• Long-term capital gains tax: 10% on gains above ₹1 lakh

If you can take some risk and want higher returns in the long term, ELSS can be a strong option.

Tax Saving FD vs. ELSS

Potential for Profit

For some time now, the RBI has been reducing the repo rate, and along with it, the interest rate on bank FDs is also decreasing. Recently, the RBI reduced the repo rate by 0.25%, bringing it down to 5.25%. In such a situation, the interest on FDs may decrease further in the coming days. If the return on FDs decreases further, it will not be able to beat inflation at all.

On the other hand, while ELSS involves market risk, it also has the potential to beat inflation. This market-linked scheme is subject to fluctuations, but the chances of recovery over time are higher; therefore, ELSS becomes a profitable investment in the long term.

Lock-in Period

Tax-saving FDs have a lock-in period of 5 years. You cannot withdraw it prematurely. But ELSS has a lock-in period of 3 years. This is the shortest lock-in period compared to PPF and tax-saving FDs.

Tax Benefits

Both Tax Saving FD and ELSS offer tax benefits under Section 80C. The interest earned on Tax Saving FD is taxable. It is added to your income and then taxed according to the tax slab. In ELSS, when you sell it after the 3-year lock-in period, the profit earned is considered long-term capital gains. Profits up to ₹1.25 lakh in a financial year are completely tax-free. A tax of 12.5% ​​is levied on profits above ₹1.25 lakh.

FD or ELSS, which to choose?

Both Tax Saving FDs and ELSS are good ways to save on taxes, but ELSS is more powerful in terms of returns and lock-in period. FDs offer security, while ELSS has the potential to generate higher returns in the long term. The right choice depends on your risk tolerance and investment goals. However, before making a lump sum investment in ELSS, be sure to consult a financial advisor, as the timing of the investment is very important.

FAQs

Q1. Can I lose money in ELSS?
ELSS is linked to the stock market, so fluctuations are possible, but the chances of loss decrease in the long term.

Q2. Can I withdraw money from a Tax Saving FD before maturity?
No, there is no provision for premature withdrawal before the 5-year lock-in period.

Q3. Why does ELSS have the shortest lock-in period?
The government wants to promote equity investments, which is why ELSS has a lock-in period of only 3 years.

Q4. Can I invest in both FD and ELSS for tax saving?
Yes, but the total deduction under Section 80C will be limited to ₹1.5 lakh.