Bank deposit is not a good investment option always

[melvin@finvin.in]

Bank Deposit is not a good investment option always
The heading sound misleading? Yes, because all of us feel that the bank deposit is the best investment opportunity which gives 100% safety and peace of mind. No wonder why all of us have good chunk of our savings in bank deposits. Let us see why I made the above statement that bank deposit is not a good investment always.
1. Bank interest is fully taxable
You are aware that the bank will deduct tax at the rate of 10%, if the interest payable in a year is above 10,000. Many depositors are under the impression that the tax liability is only 10%. It is wrong. The bank interest attracts tax as per your tax slab. If you are in the 30% tax slab, then you are liable to pay tax at the rate of 30% for the interest income. If the bank has already deducted 10% as TDS, then you are liable to pay the additional 20% tax as self assessment tax. If you don’t pay this tax, you may get a tax notice from Income tax department. This is because the entire interest paid data is available to the tax department from the bank.
Imagine you are in 30% tax slab and have invested 5 lakhs in a bank deposit which offers you 9% interest. You will get 45,000 as interest for the year. The bank will deduct TDS of 10% on this. You have to pay another 20% tax on this interest of 45,000. In effect after 30% taxation, you will have 31,500 in hand as interest income. This works out to 6.3% return only. Though you are getting 9% interest, your actual gain is only 6.3%. I have ignored the 3% surcharge on tax.
2. Bank interest is taxable on accrual basis
Suppose you are in 30% tax slab and invested 5 lakhs on 1st April 2014 in a 3 year deposit offering 9% interest. The deposit will mature for payment on 1st April 2017.When you are liable to pay tax on the interest income?
You have to pay tax every year on the accrual basis. For example, in the above example, you are liable to pay tax for the interest accrued for the financial year 2014-15. In this case, the bank will deduct TDS at the rate of 10% and you have to pay another 20% of the interest. The bank will issue a certificate every year stating the accrued interest and the TDS deducted. Based on this, you have to add the interest income to your other taxable income and pay the balance tax. The effect of compounding will be reduced in bank deposit, because only the accumulated amount net of 10% TDS goes for the second year and so on. In reality, you pay tax even before you get the maturity amount in hand.
Is there any better option than bank deposits?
Yes, Debt mutual funds are better than bank deposits. Before going into the tax benefits of debt funds, let us see what we mean by debt funds.
This is a special type of mutual funds, where the money is invested in fixed income instruments like bonds, treasury bills and money market instruments. There are different types of debt funds depending on the types of securities invested. These funds are not volatile like equity mutual funds and can offer returns similar to the bank deposits.
Why debt funds are better than bank deposits?
In debt mutual funds the taxation is like capital gains. Let us see how it reduces your tax liability.
1. In debt funds, the tax liability arises only on selling the funds. If you invest 5 lakhs in a debt fund on 1st April 2014, you are liable to pay tax only at the time of selling the fund. There is no tax liability on accrual basis. If you are selling it after 10 years, the tax liability is postponed till the date of selling. This way you can earn better returns compared to bank deposit, where you are discharging tax liability every year on accrual basis.
2. In debt funds, your tax liability is based on the duration of your holding period. If you are selling the fund after holding it for more than 3 years, your gains will be treated as long term capital gains. The long term capital gains will be taxed at 20% after indexation. Indexation is a process whereby your cost price will be increased to offset the effect of inflation. Government will notify the cost of inflation index every year to calculate such gains. Let us explain this with an example.

Suppose you have invested 5 lakhs in debt mutual fund on 1st April 2010 and sold it on 2nd April 2014 after 4 years of holding. The amount you got while selling is 7, 05,790. This is a return of 9%. Let us see how your tax liability is calculated on your gain of 2, 05,790.
The cost of Inflation index for the FY 2010-11 is 711 and the index for 2014-15 is 1024. The indexed cost of your investment of 5 lakhs will be 500000 x 1024/711 = 7, 20,113.
So, in effect, you have a capital loss of 14,323 (720113 – 705790 = 14,323). You can adjust this loss against any gain of this year. Otherwise you can carry forward this loss to be adjusted against any gain in the next 8 assessment years. So, in this case, you need not pay any tax on the actual gain of 2, 05,790. During the period of high inflation like this, you will end up paying nil tax like this. Otherwise, the tax liability can be around 2- 3% only.
But if you are selling the debt funds within 3 years, then your gains will be taxed as per your tax slab.
So, debt mutual funds are offering better option to invest in fixed income instruments with very low tax implication.

Melvin Joseph
SEBI registered Investment Adviser
Certified Financial Planner
SEBI Registration Number – INA000000342
Finvin Financial Planners
10, Olive Excel CHS, Plot No – 16, Sector- 42
Seawoods, Nerul – 400706
Mobile: 9820843739
Website: http://www.finvin.in

        

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