Debt funds vs Bank FD: Which is the most tax efficient investment? | Techy Kings


Fixed deposits and debt mutual funds are among the most popular assets for risk-free investors. Despite rising interest rates, fixed deposits have proven to be a reliable option for Indian retail investors, while debt funds are mutual funds that invest in debt securities. Debt funds generally show to provide better annual returns than FDs, although bank FDs have a lower risk profile thanks to DICGC protection. Risks associated with debt mutual funds include credit risk, interest rate risk, inflation risk and reinvestment risk, while risks associated with fixed deposits include liquidity risk, default risk and inflation risk. Although the two investment categories are mostly equivalent in terms of risk and returns, there are significant tax differences between debt funds and fixed deposits.

Tax treatment on fixed savings and debt mutual funds

Dr Suresh Surana, Founder, RSM India said “Taxation of mutual funds depends on the holding period of the 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 (ie 3 years) are categorized as short-term capital gains and are taxed at marginal slab rates imposed on investors. On the other hand, units held for more than 36 months are long-term capital gains which are taxable @ 20% u/s 112 of the IT Act after getting the benefit of indexation. Further, any dividends earned from debt mutual funds are taxed at the marginal slab rate applicable to the investor.”

He further said that “One earns Interest Income from FD and the same is taxed at the Marginal Income Tax slab rate. However, no tax is levied on Bank FD maturity proceeds, however, the bank will deduct TDS at 10%, if the amount of interest paid to a resident individual exceeds Rs. 40,000 (Rs. 50,000 in case of senior citizens). Tax efficient option for any investor will depend on various factors like return earned on investment, applicable tax bracket, nature and duration of holding (for example, cost indexation benefit available in case of long term debt mutual fund), FD interest deduction up to Rs. 50,000 available u/s 80TTB for senior citizens, etc.”

Key differences between bank FDs and debt mutual funds

Mr. Sandeep Bagla,CEO, TRUST MF said “Liquid/Debt Funds & bank FDs can be used to invest short-term surplus and earn moderate returns with low risk.

1. Although securities in Liquid Funds are subject to daily mark-to-market, FDs provide returns without volatility.

2. Most debt funds are open-ended and do not charge any exit loads. In case of FD, there is a penalty for early withdrawal through the deposit period.

3. If interest rates fall, liquid funds can provide higher returns than portfolio yields, and vice versa. The FD rate of return remains the same throughout its tenure.

4. In the debt scheme, if the investor remains invested for 3 years or more, the effective tax rate is 20% with indexation interest. In FD Bank, investors have to pay tax at a marginal rate which can be as high as 30-40%

5. FD Bank is unsecured, while the debt fund is secured by the securities it holds. Debt Funds can be preferred over FDs, as debt funds are guaranteed, offer better liquidity, potentially higher returns than portfolio yields and are far more tax efficient.”

Comparison of returns between bank FDs and debt mutual funds

Nitin Rao, Head Products and Proposition, Epsilon Money Mart said “When it comes to fixed deposits, we Indians have a long relationship with it. Except for Real Estate, it gets a large allocation in all India portfolios. Debt funds are closest to FDs in terms of risk. They have slightly better returns between 7-9% as against 6-8% in case of FD. Other benefits include higher liquidity and also SIP routes are allowed. Taxes are where debt funds hit it out of the park. First in the long term, FDs are taxed according to the tax slab while Debt funds are taxed at 20%. In addition, they carry the benefit of indexation, meaning tax payments will be made after adjusting for inflation.”

Where should you invest?

Mr. Ajay Lakhotia, Co-Founder, StockGro said “Debt funds outperform FDs in the ever-changing macroeconomic scenario. They provide slightly higher returns with the same level of risk and offer better benefits for investors in higher tax slabs. Long-term debt investments come with indexation benefits at a 20% tax rate. And features like dividends, early withdrawals & SIPs translate into better inflation protection. At over $2 trillion in size, India’s bond market is one of the largest in Asia. It is a sea of ​​opportunities and many risk averse players like banks, insurance companies & FIIs dominate this space. It’s time for retail investors to start taking advantage of it too.”

Disclaimer: The views and recommendations made above are the views of individual analysts or brokerage firms, and not of Mint.

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