The Buyt Desk
Fixed deposits (FDs) and debt mutual funds are among the most prominent debt investment options for conservative investors. Compared to FDs, debt funds come with low risk. However, for regular investment options and liquidity, debt mutual funds steal the show.
The short-term capital collected on debt fund investments for under three years is liable to be taxed as per your tax slab rate. However, long-term capital which is gathered on debt fund investments held for over three years is accountable to a 20 percent tax rate with indexation benefits. Capital collected on FD returns is subject to tax slab rates.
According to financial advisors, if investors fall into a higher income tax bracket then debt funds are a more tax-efficient investment as compared to FDs. Want to know how? Keep on reading.
Bank FDs and Debt mutual funds are perfect for investors having low to moderate risk profiles. In terms of taxation, Debt mutual funds provide much better tax efficiency than bank FDs. The reason is that income from debt mutual funds is taxed differently. The interest income gained from bank FDs is taxed according to the tax slab of an individual. On the other hand, the income earned from debt mutual funds is taxed depending on the short-term as well as long-term Capital Gains.
When debt mutual funds are used after holding it for over 36 months then long-term capital gain is taxed at the rate of 20% with indexation benefit. However, when debt mutual funds are held for less than 36 months, a short-term capital gain is taxed at the tax slab of an individual.
Let us assume that you spend INR 1 lakh in a debt mutual fund for 4 years. It has generated a CAGR of 8%. After 4 years, your investment value will be approximately INR 1,36,000. You will have about INR 36,000 gain. When you consider the indexation benefits i.e. inflation adjustment, tax liability you will get on selling the debt mutual funds will be ₹3,566.
When you invest the same amount in FD, with similar return and tenure, you would have to pay a tax of INR 10,800 seeing the investor falls in the 30 percent tax bracket. The tax implications on Debt mutual funds and bank fixed deposits would be the same when investments are held for less than 3 years. Debt mutual funds are comparatively beneficial investment options in the higher tax bracket with an individual’s tax bracket and long-term gain taxation.
Remember that banks are regarded as almost risk-free based on the risk and return comparison because investment is insured up to INR 5 lakh extent. Even the returns are also pre-set. However, returns are market associated with debt mutual funds and are accountable for the risk of interest rate, inflation risk, and default risk.
In another interview, the spokesperson said that for taxation on FD and debt mutual funds, the latter gains a benefit for more than 3 years and above than that. Moreover, FDs earned interest is also taxed according to the income slab rate of the investors. But, no tax is charged on the bank FD’s maturity proceeds. TDS will be deducted by the bank at the rate of 10% when the paid interest amount on a fixed deposit goes beyond INR 40,000 or 50,000 in a senior citizen’s case.
For debt mutual funds, the taxation is based on the holding period (holding period of fewer than 3 years). However, when it comes to the working process of fixed deposits and debt fund taxation, there is not much difference between both. But, the profits or gains are taxed at 20 percent after indexation when you redeem a debt mutual fund after three years. The term indexation here refers to the process of adjusting the investment value in accordance with inflation to shield your capital gains against tax corrosion.
