Tag: Financial Awareness

Fixed Deposits V/s Fixed Income Funds (Debt Fund)

No need to define What is Fixed Deposit as every Indian knows about it, we Indians are as aware about Fixed Deposits as we are aware about Saving bank accounts, we have been taught for generations about the advantage of Fixed Deposits, Rather awareness of Debt Fund is still in nascent phase and its superiority over Fixed Deposits specially in terms of tax efficacy is still little known.

Before answering How Fixed Income Funds or Debt Funds offer you better Returns and more advantages than a Fixed Deposit, Lets understand what are debt Funds?, NOT All Mutual Funds Invest in Equity Share Market, yes there is a category known as Debt Mutual Funds mainly invest in a mix of debt or fixed income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons

Let’s Understand how Debt fund Offer Several Advantage over Fixed Deposits

(1) Taxation

Fixed Deposits

Interest Earned from FD is taxed as per your Income Tax slab Rate, This means, if you are in the 30% tax bracket, you will have to pay 30% tax on your interest income from FDs.

Debt Funds

Short Term Capital Gain – Short Term is a holding period of less than 36 months. On short-term capital gains you are taxed at your slab rate (Taxation is Similar as FD).

Long Term Capital Gain – Long Term is a holding period of more than 36 months. On long-term capital gains you are taxed @20% with cost indexation benefits, at the time of sale.

Cost Inflation Index

Cost Inflation Index (CII) is as measure of inflation that is used for computing long-term capital gains on sale of capital assets. It comes under section 48 of the Income Tax Act,First Index was declared for Year 1981-82 as 100.

Calculation of Long Term Capital Gain Tax, Formula for computing indexed cost

(Index for the year of sale / Index for the year of acquisition) * Cost

Example : Suppose In year 2015 Mr. A invested 10lakh in FD with interest rate 0f 8% Compounded for 36 months, same time he invested 10Lakh in Debt Fund which also offered 8% compounded over 36 months period. Let’s assume Mr. A has tax slab of 30% for the year 2018

In both cases his 10lakh will become 1259712 in 2018, now comes the taxation part.

Fixed Deposits Taxation: Total Interest earned over the period 259712, so tax will be30% of 259712, i.e. 77913,

Now the net maturity in hand will be 1258712 – 77913 = 1181799,

So the real rate of return will be 5.73% (return post tax) for the Fixed Deposit of 8%

Debt Fund Taxation: Here too the gain part is 259712, but to arrive taxation we need Cost inflation Index, Which is 254 for 2015-16 and 280 for 2018-19, Now

(Index for the year of sale / Index for the year of acquisition) * Cost

(280/254) * 1000000

1.1024 * 1000000

1102400, Now the net gain for taxation is 1259712 – 1102400 = 157312

Now 157312 will be taxed at flat rate of 20%, i.e. 31462

Maturity at hand will be 1259712 – 31462 = 1228250

Where real rate of Return is 7.1% (return post tax)

So Debt fund saved Tax of Rs 46451/- over Fixed Deposits for Investment of 10Lakhs for 3 years, this gap may be widen if amount or tenure is more

(2) No at source deduction

In Case of Fixed Deposits tax bank deducts tax at the rate 10% on yearly basis, regardless of your tax slab if you are not liable to pay tax you have to submit form 15H/15G, in case you are at higher slab you have to deposit difference tax before filing your income tax returns

But for Debt Fund there is no tax deduction at source (TDS) on the gains, no annual taxation is required tax is deferred indefinitely till the investor redeems his units; taxation will be calculated once you redeem units of Debt Fund. The gains from a debt fund can be set off against short-term and long-term capital losses you may have suffered in other investments

(3) Liquidity

On liquidity front, debt funds (barring Fixed Maturity Plans) proceeds are credited within a period of 2-3 working days after redemption, many funds charge exit loads, ranging from 0.25–1% of the redeemed amount, if they are redeemed within a pre-specified period. Such periods can range anywhere from 15 days to 12 months, some debt funds like liquid funds, Ultra short-term and many short-term funds do not charge exit loads. Such debt funds will suit best to park your emergency fund.

FDs are also typically available at 1-2 day’s notice, but usually, carry a penalty if they are redeemed before the maturity date; Banks penalize to de-motivate premature withdrawal of FDs by paying lower interest rate than the actual interest rate.

(4) Transparency

Debt fund provides great amount of flexibility and transparency. You have always have option, you can switch/redeem based on your view, market conditions etc. When you go with bank FD you do not know where the money is invested. When it comes to debt funds you have the transparent portfolio in front of you each month and the daily NAV which let you know daily value of your investment which is not the case in Fixed Deposits. That is surely an advantage for the investor. Also, you can choose SIPs route to invest in debt.