Actual Returns From Your Fixed Deposit Might Surprise You

Rate of interest 5% to 5.3% on fixed deposits of 3 years to 5 years are offered by big banks like SBI, HDFC, ICICI. Rates for senior citizens range from 20-60 basis points higher. These are the lowest interest rates in nearly two decades. On the other hand, inflation is floating around 5-6%.

“Interest rates in India and most major economies are at historically low levels due to measures taken by global central banks, including the RBI, to support economic growth in the aftermath of the pandemic. Due to the combination of these monetary measures and fiscal support provided by governments, economic growth has improved well, resulting in inflationary concerns, said Dhaval Kapadia, Director-Managed Portfolios, Morningstar Investment Advisors India.

Also, investors often overlook the tax implications on the final return from fixed deposits. Interest from fixed deposits is fully taxable, which means higher the tax slab, lower will be the returns.

Let us understand the effect of tax and inflation on returns on FD with an example.

For an investor in the tax slab of 30% (without cess and surcharge), a 3-year FD with an interest rate of 5.5% will fetch 3.79% after tax. Now, given that the Consumer Price Index (CPI) inflation has been pegged at 5.3% by RBI for FY22, the real return on FDs is essentially around -0.9%.

SBI, in a research paper released last month, suggested that the time has come to rethink the taxation of interest on bank deposits, in which the real rate of return on bank deposits has remained negative “for quite some time”. Until then, experts advise that investors should look at other fixed income instruments and low-risk debt products that are tax-efficient and capable of delivering better returns than fixed deposits.

Think tax before return

Praleen Bajpai, Founder, Finfix Research & Analytics said that choosing small savings investment options according to your tax slab can make a big difference in the ultimate return of an investor.

For example, post office time deposits and National Savings Certificates (NSCs) offer slightly higher interest rates of 100-120 basis points compared to FDs. However, the tax treatment of interest on both the options is same as that of FD.

cut up to ₹1.5 lakh NSC on deposits and for 5 years deposits can be claimed under section 80C. For this reason, most post office savings schemes are not much different from FDs for people in higher tax brackets.

Bajpai said that as a general rule, investors in higher tax brackets should avoid products where taxation is at the income tax slab level.

He suggested that investors should look beyond fixed income products for better tax-efficient products. “Broadly speaking, a combination of arbitrage funds and debt mutual funds can work for investors who are in higher income slabs. While arbitrage funds offer equity taxation, debt funds offer indexation benefits when held for three years.

Debt funds are the best bet for long term

According to financial planners, Debt Mutual Funds are a clear winner among all debt investment options for longer investment horizon from taxation point of view.

In case of debt funds held for more than three years, the indexation benefit reduces the tax significantly. Long term capital gains on debt funds are taxed at 20% with indexation, which increases the purchase price after considering inflation during the holding period. This reduces the effective tax to 6-7%. Short-time capital gains on debt funds are taxed as per the tax slab.

“Investors subject to higher tax slabs can consider debt funds in categories like banking and PSUs, corporate bonds and medium to long term funds, where yields are marginally higher than FDs and returns are less taxable for three-year tenors. will be subject to rates. And up,” said Kapadia.

Debt funds are capable of delivering better returns than traditional fixed-income instruments; However, investors should note that they carry risk, albeit less, because they are market-linked.

Suresh Sadagopan, MD and CEO, Ladder7 Wealth Planners said, “Even though the low interest rate regime is proving to be a challenge for security-seeking investors, one should not turn to riskier instruments in search of returns.

Seniors most affected

Senior citizens are feeling the pinch of negative real returns on FDs the most as most of them deposit a major part of their retirement corpus in FDs and rely on the interest income from them for their regular expenses.

Santosh Joseph, Founder and Managing Partner, Germinate Investor Services LLP said that it is time senior citizens look beyond FDs and consider spreading their retirement funds across fixed income and low risk investment options.

“They can use government-backed schemes like Senior Citizen Savings Scheme (SCSS) and Pradhan Mantri Vaya Vandana Yojana (PMVVY) to get better results.”

Currently, SCSS is earning the highest interest rate of 7.4% among all the government backed schemes. The scheme ensures regular flow of income in retirement as the interest amount is paid quarterly to the account holder. Though interest on SCSS is fully taxable and also subject to TDS, principal is available for tax deduction ₹1.5 lakh under section 80C.

PMVVY comes with a long lock-in of 10 years. The biggest advantage is that the scheme provides guaranteed pension to retirees at the rate fixed at the time of initiating the scheme. The interest rate on PMVVY is revised annually by Life Insurance Corporation of India (LIC), the rate for the current financial year is fixed at 7.4%.

Reserve Bank of India floating rate bond is another option, which is currently giving 7.15% returns. Interest is paid every six months and is not cumulative.

“In order to reduce the tax liability in higher income slabs one can use the tool of Systematic Withdrawal Plan (SWP) from Debt Mutual Funds. Investors who wish to manage domestic investments with their requirement, should have 10-25% (as the case may be) of the portfolio in equity-oriented products to ensure some growth in the corpus for the coming decades.