Though investment instruments carry with them financial risks, there are options available in the market for risk-averse investors. Two of them are bank FDs (fixed deposits) and debt MFs (mutual funds). While bank FDs are term deposits with the banks, debt MFs are mutual funds that invest in debt securities. Both of them have different tax rules and rates. Here’s where you should invest to save more taxes.
Debt mutual funds include credit risk, interest rate risk, inflation risk, and reinvestment risk; while FD risks include liquidity risk, default risk, and inflation risk. According to a livemint report, debt funds have generally shown to have delivered better-annualised returns than FDs, although bank FDs have a lower risk profile thanks to DICGC coverage.
Both debt funds and bank FDs can be used to park short-term surpluses and earn moderate returns with low risk. While securities in a liquid fund are subject to daily mark-to-market, fixed deposits provide returns without volatility. In debt schemes, if an investor remains invested for 3 years or more, the effective tax rate is 20 per cent with indexation benefits. In Bank FDs, an investor has to pay tax at the marginal rate which could be as high as 30-40 per cent.
The report quoted RSM India founder Suresh Surana saying: “The taxation of debt mutual funds depends upon the period of holding of such funds. In accordance with section 2(42A) of the Income Tax Act, 1961 (hereinafter referred to as ‘the IT Act’), Debt oriented mutual funds held for up to 36 months (i.e. 3 years) are categorized as short-term capital gains and taxed as per the marginal slab rates applicable to an investor. On the other hand, units held for more than 36 months are long-term capital gains taxed @ 20 per cent u/s 112 of the IT Act after availing the benefit of indexation. Further, any dividend derived from debt mutual fund is taxed as per the marginal slab rates applicable to the investor.”
He, according to the report, added, “One earns Interest Income from FD’s and the same is taxed at Marginal Income Tax slab rates. However, no tax is levied on the maturity proceeds of a Bank FD, however, the bank would deduct TDS at 10%, if the interest amount paid to a resident individual exceeds Rs. 40,000 (Rs. 50,000 in case of senior citizen). The tax-efficient option for any investor would depend upon various factors such as the return derived from the investment, applicable tax bracket, nature and time period of holding (for instance, cost indexation benefit available in case of long-term debt mutual funds), FD interest deduction upto Rs. 50,000 is available u/s 80TTB for senior citizen, etc.”
Where You Should Invest?
Ajay Lakhotia, co-founder of StockGro, said debt funds outrank FDs in a constantly evolving macroeconomic scenario. They provide marginally higher returns with similar risk levels and offer better benefits for investors in higher tax slabs. Long-term debt investments come with indexation benefits at a 20 per cent tax rate, according to the livemint report.
“And features like dividends, early withdrawals & SIPs translate to better inflation protection. Sized over $2 trillion, the Indian bond market is among Asia’s largest. It is an ocean of opportunity and many risk-averse players like banks, insurance companies & FIIs dominate this space. It’s time for retail investors to start leveraging it too,” Lakhotia said, according to the livemint report.
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