PPF, Mutual Funds Or Bank FD? Where To Invest For Dual Benefits Of Tax Saving & Wealth Creation

Who doesn't want to save tax? Surely everyone who falls into the taxable income category wishes to save tax, right? And what about wealth creation through investment? That's equally important for most of us to fulfil life goals such as retirement corpus, a child¡¯s higher education, home loan down payment, etc, isn't it?

But despite the importance of both tax saving and wealth creation, more often than not, many of us end up compromising on either of them to fulfil one. But what if we told you that you can achieve not just one but in fact both these goals through investment and tax saving instruments such as PPF, tax saver bank FD and ELSS (Tax saving mutual funds)?

Curious to know? Read on as we explain these investment avenues and compare them to help you choose the most suitable one to get the best of both worlds, i.e. wealth creation and tax saving!

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1. Capital protection & risk

Bank FDs, including the five-year tax saver ones, are covered under Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of RBI, for an amount of Rs 5 lakh per bank per depositor. This holds true for covering both interest and principal in case of bank failure. This insurance cover extends also to other forms of bank deposits such as savings, current and recurring. In case you hold deposit accounts in more than one bank, Rs. 5 lakh cover would apply separately to each bank, provided the bank is included in RBI¡¯s list of scheduled banks.

On the other hand, PPF is managed by the Government of India, with both the principal and the interest components coming with a sovereign-backed guarantee.

As far as ELSS is concerned, they are prone to be exposed to the volatility of equity markets. However, this risk can be mitigated by staying invested for the longer term and choosing the SIP route for investing in ELSS. SIPs ensure regular investments periodically, which helps in averaging out the cost during market ups and downs through the rupee cost averaging concept, thereby helping to generate higher returns, especially over the long term, without the need for market timing.

2. Returns

Bank FD interest rates widely across public and private sector banks, with five-year tax saver FD's rate currently hovering in the range of around 5.50%-7.25% p.a. Remember that FD rates remain fixed till its maturity tenure, irrespective of the changes in the FD¡¯s card rate during that period. For instance, if you have opened a bank FD for 5 years (like in the case of tax saver FD) at the card rate having 6% p.a. interest rate, then that interest rate will stay the same for the entire tenure of 5 years.

Whereas for PPF, interest rates are set on the basis of government bond yields. Currently, the PPF interest rate is 7.1% p.a for the July-Sept 2022 quarter. It's worth noting that contrary to popular perception, the interest rates of PPF do not remain fixed throughout the entire tenure. The Finance Ministry reviews PPF interest rates along with other small saving schemes on a quarterly basis.

On the other hand, ELSS returns depend on their fund portfolio¡¯s performance. However, with the inherent risk of equities in the case of ELSS comes the fact that more often than not, ELSS returns tend to beat both inflation and all fixed-income instruments by a wide margin, especially over the long term. For example, ELSS as a category currently generates annualized average returns of 13.29% for 5 year period, 7.74% for 1 year period and 32.22% for 2 year period (according to moneycontrol data as per 30.08.2022 returns).

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Also Read: Does It Make Sense To Invest Your Money In A FD Anymore?

3. Taxation

PPF¡¯s maturity proceeds and interest income do not attract any tax, which makes its post-tax returns one of the highest amongst various fixed-income tax-saving investments.

For bank FD investors, tax liability does not end with a TDS deduction. Interest income from FDs, even in the case of five-year tax saving FDs, is included in your annual income and then taxed in accordance with your income tax slab.

Meanwhile, long-term capital gains (LTCG) of up to Rs 1 lakh in a financial year realized from ELSS are tax-free. Whereas gains above Rs 1 lakh in a year attract LTCG tax of 10%. ELSS¡¯ short-term capital gains (STCG) attract a tax of 15%.

4. Lock-in period

When compared to ELSS and tax saver bank FD, the biggest disadvantage of PPF lies in its long lock-in period of 15 years. However, for some degree of liquidity, PPF does allow the facilities of partial withdrawals, loans and premature closure, subject to certain applicable conditions regarding the year in which it can be withdrawn, the reason, and the amount that can be withdrawn.

On the other hand, with the shortest lock-in period of three years, ELSS offers one of the highest degrees of liquidity amongst all tax-saving investment options under Section 80C. But remember that it is usually advisable not immediately redeem the ELSS investment after three years of lock-in, and to remain invested in order to maximize the return potential of equities.

As far as tax-saver bank FDs are concerned, they have a lock-in period of five years, and most banks usually do not allow you to even take a loan against tax saver FD.

5. Tax benefits

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It's important to compare these investment plus tax saving options on the above-mentioned grounds because, in terms of tax benefits, all three offer the same advantage under Section 80C of the Income Tax Act. The maximum limit for availing tax benefits under Section 80C is Rs 1.5 lakh in a financial year, including all other eligible tax saving options that fall under the wide umbrella of this section, such as home loan principal, life insurance premium etc.

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