- Income from fixed deposits is fully taxable. In the highest 30% tax bracket, the effective return from the fixed deposit is barely 4.8%.
- Investors can still gain from the hike in interest rates by opting for debt funds and fixed maturity plans.
The biggest beneficiaries will be senior citizens. Besides the 0.5% higher interest, this year’s budget has also exempted interest income of up to Rs 50,000.
However, general investors may not gain so much. Income from fixed deposits is fully taxable. In the highest 30% tax bracket, the effective return from the fixed deposit is barely 4.8%. Given that inflation is at 5%, the real rate of return will be in the negative.
How inflation eats into your returns
Investors can still gain from the hike in interest rates by opting for debt funds and fixed maturity plans. Though debt funds have not given very good returns in the past one year, analysts expect them to churn out decent returns in the coming months.
Debt funds and fixed maturity plans are also more tax efficient than fixed deposits. If held for over three years, the gains are treated as long-term capital gains and taxed at a lower rate of 20% after indexation. Indexation takes into account the inflation during the holding period and accordingly raises the acquisition price of the asset.
The raising of the acquisition price reduces the gain from the asset and thereby cuts the tax. In times of high inflation, the tax can be reduced to zero. In fact, there have been times when investors have claimed a notional loss due to high inflation. This loss can be adjusted against other taxable gains. Unadjusted losses can be carried forward for up to eight fiscals.
Interestingly, while banks have raised deposit rates for retial investors, they have cut the rates for bulk deposits of over Rs 1 crore. SBI has cut interest rate on short term bulk deposits from 6.7% to 6.2%.
1 Comment on this Story
Rajendra Kumar Agrawal847 days ago
1. The basic function of fixed income instruments like FDs is not to beat inflation, or to grow wealth, but to provide short-term safety, while not losing too much to inflation.
2. As Indian economy''s general rate of interest is determined by prevailing inflation rate, FD rates are usually very close to it, leaving a miniscule amount towards asset building and wealth creation during earning years.
3. If inflation rate is equal to its returns, the purchasing capacity of products and services still remains at the same level, but if returns are lower, then buying power erodes, despite having saved over a period of time.
4. If the inflationary situation continues to be more than returns over several years, the purchasing power becomes worse off every year, leading to a precarious situation upon reaching the retirement age.
5. In fact, it becomes even worse for a taxpayer, as FDs are fully taxable at the person''s slab rates during all his earning years till 60 - tax exemption has been introduced up to 50,000 interest from this year, but only for senior citizens.