NSC vs. 5-year bank FD: Which one offers better investment benefits?

Perhaps the best time to study tax-saving schemes is at the beginning of a tax year – like now. There is no year-end pressure to choose a scheme before the deadline, and ample time on hand to weigh various options. That being the case, why not see which of two schemes suit you best – a five-year fixed deposit (FD), or a National Savings Certificate (NSC)? 

Among the instruments that qualify for a deduction of up to Rs 1.5 lakh under Section 80C, these are among the most preferred options. The two schemes are offered by banks as well as NBFCs, and come with various features and benefits that appeal to people with different needs and goals. Read on to find out what works for you.

Features of NSC and FDs

Related: Floating rate savings bonds: What makes them attractive for senior citizens?

NSC versus FD: the specifics

Now that we have studied the main points of each, let us look at the two savings schemes separately against various heads for a better perspective.

Rate of interest: The Indian government fixes the rate of interest for NSCs from time to time, the current rate being 6.8%. This may or may not be higher than bank rates – it depends on which bank you are making the comparison with; bank rates can go up to 7%, while NBFCs offer even more.

Moreover, because tax is computed quarterly in case of FD and half-yearly for NSC, the former enjoys a small edge. Also, keep in mind that senior citizens get a higher rate of interest. So on paper, the interest earnings from bank FDs can be more; but that is before taxes.

Taxable returns: This brings us to what matters – what you get after tax on earnings. The first point to note here is that returns on both NSCs and FDs qualify for a deduction of up to Rs 1.5 lakh under Section 80C. When tax is applicable on interest earnings, TDS at 10% come into play for FDs, while in the case of NSC, the investor does not receive the interest earned, which gets reinvested and accumulated.

Also, these returns on NSC enjoy tax exemption under Section 80C of the Income Tax Act, making the effective returns through NSC higher. However, In order to claim the interest deduction, the investor has to show the interest earned for the year in the income tax return as ‘other income’ and claim the interest as deduction under Section 80C under Chapter 4 of the income tax form.

Investors of bank FD can either accumulate the interest and receive payment on maturity or opt for a quarterly payment. However, they cannot claim tax deduction under Section 80C for the earned interest.

Related: FAQs about fixed deposits

Lock-in period: Both instruments have a lock-in period of five years and no upper limit on investment, which means neither enjoys an edge. However, experts have often spoken in favour of NSC, given the higher interest rates it is offering currently and the interest deduction benefit under Section 80C.

Premature withdrawal: Early withdrawals are difficult in both cases and can be penalised. Typically, withdrawal of NSC investments before the maturity period of five years is allowed only under certain very specific conditions, as mentioned below:

• Demise of the certificate holder;
• On forfeiture of the certificate to a gazetted officer;
• Under order from a court of law.

Withdrawal from the scheme within a year will not fetch any interest and in fact, is liable to invite a penalty. It is the same with FDs – there is a penalty on premature withdrawal.

Loans: Having lock-in periods of five years and being stable financial instruments, NSCs can easily be used as collateral for availing loans for vehicles, housing, and other secured loans. With five-year tax-saving FDs, however, this feature is unavailable, though in general, loan against FDs deposits is allowed for both individual accounts and joint accounts. 

Credit card collateral: Many banks such as SBI offer credit cards against FDs with credit limits generally ranging from 75% to 85% of the FD amount. A secured credit option, these credit cards require you to open an FD of at least Rs 25,000. On the other hand, NSCs are not allowed to be used as collateral for credit card.

Risk: As NSCs are issued by the Indian government, the interest rates offered are not known to change in any significant fashion, making this one of the safest investment options in the country.

There is investment security for FDs too, especially when the bigger banks are involved, but one cannot say that risks do not exist. In fact, FDs with public sector banks are often considered safer than private banks. However, you should know that FDs up to Rs 5 lakh are insured by the Deposit Insurance and Credit Guarantee Corp, an RBI subsidiary.

Related: Fixed deposit, savings account, or liquid funds? How to be financially prepared in a pandemic

Last words 

Broadly speaking, both fixed deposits and NSCs score well as investment options that grow wealth. However, it is their uniqueness that makes each suitable for specific purposes and therefore desirable as per needs.

NSCs, for example, are stable financial instruments with tax benefits – with the added advantage of enhanced returns provided you are willing to keep your money invested over a longer period. Fixed deposits too offer assured returns and income tax savings, but have the added benefits of flexible tenure options and liquidity, apart from another feature if that interests you: credit cards.

Looking at the broad outlines of each, the potential higher returns on NSCs over a long term make them the preferred choice for those with a distant goal, like retirement benefits in their old age. On the other hand, FDs are handy too – in terms of liquidity. So, it makes sense to set aside some amount in fixed deposits as one never knows when money may be urgently needed. You can always break the FD.

Instead of having to choose between NSC and FD, why not consider both?  FD returns vs inflation: Here's how you can keep your purchasing power intact