SBI has increased interest rates for 180 days to 210 days from 5.75% to 6% and for those from 211 days to less than a year from 6% to 6.25%. HDFC Bank has followed suit by increasing FD rates by up to 20 bps (0.2%). The rates for FDs with a tenor of 2 years 11 months to less than three years have been increased to 7.15% from 7%. Interest on FDs from 3-year 1 day to 4 years and 7 months has been revised upwards from 7% to 7.2%.
Bank FDs are no doubt a safe investment option compared to fixed income mutual funds (MFs). But there are several factors that one should consider before deploying funds. Here is a summary of what investors should keep in mind while making their choice about fixed income investments.
FDs are secure but fixed income mutual funds offer more
Bank FDs are one of the most secure investment options. It works well for senior citizens who want a stable and regular income. But the entire spectrum of fixed income MFs including fixed maturity plans, long duration debt funds, gilt funds and liquid funds offer higher returns than bank FDs.
Long duration debt funds, which invest mostly in fixed income securities issued by the ‘Government of India’, were the best performers among debt MFs, delivering returns of about 7.9% for the one-year timeframe. Fixed maturity plans, which are considered a proxy for FDs among debt MFs as they invest heavily in certificates of deposits issued by banks, provide a 1-year return of 6.9%. In contrast, bank FDs with a similar tenure give only around 6.5% interest.
“Bank FDs usually offer lower interest rates compared to other products in the fixed income investments space,” says Suresh Sadagopan, managing director and founder, Ladder7 Wealth Managers, a Mumbai-based wealth management firm.
But the absence of risk is what makes bank FDs an attractive proposition. “There is virtually no default risk (in bank deposits). Bank FDs are easy to understand and suit senior citizens well as they get regular, stable returns,” Suresh says.
Fixed income mutual funds offer liquidity
Fixed income MFs offer liquidity as investors can redeem the units as they wish. But this is not the case with bank FDs. Premature withdrawal of FDs, which usually come with a lock-in period, attract penalty. This pushes down the income from these instruments drastically.
“The biggest advantage that works in favour of debt MFs is liquidity,” says Rupesh Nagda, founder and CEO, Family First Capital Advisors, a Mumbai-based investment boutique specialising in family office, portfolio and wealth management services.
Watch for the tax impact
Though the Union Budget 2023 has made it a level playing field for bank FDs and fixed income MFs by taxing them similarly, investors should still look at taxation closely as there are products that enjoy a tax-free status. For instance, investments in tax-saving FDs, which typically come with a lock-in period of five years, are exempt from tax under Section 80C of the Income Tax Act. In this case, both the actual and post-tax return will be the same.
Do remember that not all FDs are tax exempt. For regular FDs, the interest income is added to the regular income and taxed. If the interest income from FDs is more than ₹40000 per year, investors with PAN (Permanent Account Number) would be liable to pay 10% as TDS (Tax Deducted at Source) and for those without PAN a 20% TDS is imposed.
The TDS limit for senior citizens is ₹50000 per year. TDS is not the overall tax liability but only a part of the whole. The total tax on regular bank FDs is calculated on the basis of the individual tax slab of the investor.
No TDS is deducted for debt MFs. The tax is paid only when the investor redeems the units. Gains from debt MFs will be considered as ‘income from other sources’, added to the investor’s taxable income and taxed at her/his tax slab. Earlier, long-term capital gains from debt MFs were taxed at 20% with indexation benefit.
When income is below the taxable bracket
If your taxable income is less than the minimum taxable level of ₹2.5 lakh per year, you will be exempt from taxes. There will be no TDS deduction on the interest earned from FDs. But to be eligible for tax exemption, you have to submit Form 15H or 15G (depending on age and income) to the bank with instructions not to deduct TDS. You have to submit these forms at the beginning of the financial year. If the bank deducts TDS before the submission of forms, you can always claim a refund when you file your ITR (Income Tax Return).
The tax impact on debt MFs will be similar to bank FDs when the individual’s annual earnings are less than the tax threshold limit. Since the gains from debt MFs are only added to the income of the individual, she/he will not be paying taxes if the overall income is lower than ₹2.5 lakh per year.
Allirajan M is a journalist with over two decades of experience. He has worked with several leading media organisations in the country and has been writing on mutual funds for nearly 16 years.
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Published: 26 Jun 2024, 11:35 AM IST