By Tensing Rodrigues*
Jayanti has a query, “I have savings in the form of FDs. I pay tax on the interest that I earn from these. I am looking for options whereby I can minimize the tax I pay on my savings. What are my options?”
Before we go to the tax saving options for FDs, let us understand the taxation of interest on bank deposits. All interest from bank deposits is taxable. However interest up to Rs 10,000 from savings accounts is exempt from tax. Nevertheless it has to be shown as part of the total interest income and then deducted u/s Section 80TTA. Senior citizens are not entitled to benefits under section 80TTA. The interest from FDs is fully taxable. Interest income is to be added to the rest of the income and taxed at the applicable rate. Do not confuse this with the TDS rate. TDS at 10 per cent is deducted from your interest income if the interest from all branches of the bank exceeds Rs 10,000. But this is not the rate of tax on your interest income.
If the total income is less than what is taxable you have to claim refund of the TDS. If your total income including the interest income exceeds this limit, you have to pay additional tax. The point to make is that if TDS has been deducted on your bank interest it does not mean that the tax on your interest income has been paid.
To save tax on your investment income the best option for you is to invest in equity mutual funds which carry a lower tax. Some may suggest you to ‘invest’ in life insurance policies. Do not do that as life insurance is not an investment. Life insurance is purely to protect your dependents against your untimely death or against being afflicted by a critical illness. Insurance is for situations where a person is left with no financial support. Yes, some insurance policies called endowment plans have an investment component. They invest a part of the premium and return it with gains. But that has a specific purpose, for insurance of investment. To put it in brief, insurance policies make bad investment. They cannot be a substitute for FDs because rupee for rupee they give poor returns.
Some may suggest you to invest in some other schemes which are tax free. For instance PPF interest is tax free. But that does not make PPF always a good substitute for FDs. Currently PPF pays 7.6 per cent per annum. That compares well with the rate that you may be earning from your bank. From your query I guess you are already paying tax on your income. If you are being taxed at 5 per cent (income up to Rs 5 lakhs) then the interest rate from bank deposits (adjusted for tax) will be around 7.6 per cent that is, the same as from PPF. But if you are being taxed at 20 per cen (income from Rs. 5 lakhs to Rs. 10 lakhs), then the post-tax interest rate from FDs will be around 6.4 per cent. So you will be better off with PPF.
To calculate post-tax interest rate just do this calculation. Interest rate multiplied by (one tax rate). For instance if the interest rate is eight per cent and the tax rate is 20 per cent then the post tax interest rate will be: 8 X (1-0.20) that is 8 X (0.80); that is 6.4 per cent.
But PPF has two major handicaps. You cannot invest as much as you want in PPF. The upper limit is Rs 1.5 lakhs in a year. Secondly, it has a lock in as withdrawal cannot be made at will. It has an initial lock in of six years, that is you cannot withdraw for the first six years. After that you are allowed partial withdrawals. You can withdraw up to 50 per cent of the closing balance at the end of the 4th year prior to the year when the money is being withdrawn or 50 per cent of the closing balance of the previous year whichever is lower. At the end of the 15th year you can make a full withdrawal. To the extent that these restrictions do not come in your way you can use PPF as a partial substitute for FDs.
Beyond this, the best option for you is equity mutual funds (EMFs). Your earnings from EMFs can come as dividends or capital gains as MFs do not pay interest like FDs. The dividends from EMFs carry a dividend distribution tax of 10 per cent. The dividend tax is deducted before the dividend is paid to you. So you need not bother about adding the dividends to your taxable income. Nevertheless you are losing out 10 per cent of the dividend. Capital Gains earned on EMF units sold before one year, attract a 15 per cent tax. Those sold after one year attracts 10 per cent tax without the benefit of indexation. But there is no tax on the first Rs one lakh of such capital gains.
So you will have to do your own calculations and see what is best for you– FDs or EMFs.
* The author is an investment consultant. Readers can send their comments and queries to firstname.lastname@example.org