Budget 2008-09 brought some cheer to taxpayers, particularly senior citizens. The basic exemption limit on the annual income of individuals above 65 years of age was increased to Rs 2.25 lakh from Rs 1.95 lakh. Moreover, the two preferred plans for seniors — the Senior Citizens Savings Scheme (SCSS) and the five-year Post Office Term Deposits — were included in the basket of tax-saving instruments under Section 80C.
In January 2008, the income tax department came out with a notification stating that “investment by an individual or a Hindu Undivided Family in these two instruments during the previous year 2007-08 (relevant to assessment year 2008-09), and the subsequent years, shall be eligible for deduction under Section 80C of the income tax act, subject to the overall ceiling of Rs 1 lakh in that section.”
The notification also said “that investments made on or after 1.4.2007 shall be eligible for the deduction”.
However, the income tax notification didn’t mention anything about the lock-in period of the two schemes.
In Post Office Term Deposits, one is not allowed to withdraw the money within six months of opening the account. If the money is withdrawn within six months to one year of opening the account, no interest is paid on the deposit.
If the money is withdrawn after a year, the depositor gets an interest for the period of deposit at a rate that is 2 per cent less than the rate contracted initially.
However, in the case of the SCSS, premature withdrawals are not allowed till one year of opening the account.
For any withdrawals after one year but within two years, a penalty of 1.5 per cent of the initial deposit is deducted. The penalty is 1 per cent if the premature withdrawal is after two years.
However, in all the other tax-saving schemes under Section 80C, investments cannot be withdrawn before three to five years, depending on the instrument (see chart).
In its current format, the lock-in period of an investment is much lower in SCSS than in other fixed-income tax saving schemes, except for Post Office Term Deposits.
The interest rate in SCSS is higher than what banks are offering to senior citizens on their tax-saving fixed deposits.
Banks are offering a maximum of 8.25 per cent interest rate to senior citizens on their tax saving fixed deposits for five years or more.
Though one can receive the interest payout in bank fixed deposits on a monthly, quarterly, half-yearly or annual basis, one cannot withdraw the original deposit before five years.
In comparison, the interest in SCSS is not cumulated, which means that the depositor will have to take out the interest.
But even after taking into account the compounded interest of tax-saving bank fixed deposits, the yearly interest in SCSS stands higher.
Besides, one cannot deposit more than Rs 1 lakh in bank fixed deposits. In SCSS, one can invest a maximum of Rs 15 lakh.
After the latest round of interest rate cuts by banks, SCSS has become a more attractive fixed-income instrument, particularly for those aged between 55 years and 60 years.
Depositors in this age group don’t get the higher interest rate that banks offer to senior citizens. A depositor aged less than 60 years can get a maximum rate of 7.75 per cent in tax saving bank fixed deposits.
But a person who is 55 years or more but less than 60 years can invest in SCSS, provided the depositor has taken voluntary retirement before opening the account and the retirement benefit is deposited in the SCSS account within three months of the retirement.
Let us now compare how SCSS currently stacks up against tax-saving fixed deposits — generally banks give the same interest rate on their tax-saving deposits and ordinary fixed deposits for five years or more.
Assume that Mr A deposited Rs 1 lakh in a tax-saving bank fixed deposit and Mr B deposited Rs 1 lakh in SCSS. After three years, Mr B withdrew his money from the SCSS account. He’ll have to pay a penalty of 1 per cent of his original deposit, or Rs 1,000. In these three years, Mr B would have got a total interest payout of Rs 28,890.90 if he had reinvested the interest payments in a savings account offering 3.5 per cent interest. Hence after three years, Mr B will get Rs 1,27,890.
If Mr A had to withdraw his fixed deposit in three years, he would have got an interest rate that is one per cent less than the interest rate that the bank is offering for a three-year fixed deposit, or 6.25 per cent. At this interest rate, Mr A’s withdrawal amount would be Rs 1,20,448.28 with a quarterly compounded interest.
Though premature withdrawal is not allowed in tax-saving bank fixed deposits, we considered the premature withdrawal provisions in an ordinary fixed deposit of equivalent maturity because the interest rates are same in both the cases.
Without premature withdrawals, SCSS still scores over tax-saving bank fixed deposits. After five years, Mr A’s deposit will stand at Rs 1,46,784.29 and Mr B’s will be more than Rs 1,49,890.37, assuming that Mr B saves his interest payouts in a savings account with a 3.5 per cent interest rate. If Mr A and Mr B are both senior citizens, the difference in maturity amounts will be only Rs 536 in favour of Mr A after 5 years.