A penny saved is a penny earned. This becomes especially important for fixed income investors in the low interest rate environment where there is a risk of negative real interest rate as well.
Tax is the main culprit that brings down post-tax returns on your investments further. But do you know that A penny saved is a penny earned. This becomes especially important for fixed income investors in the low interest rate environment where there is a risk of negative real interest rate as well.
Tax is the main culprit that brings down post-tax returns on your investments further. But do you know that tax deducted at source (TDS) on the interest income earned also lowers the returns? This can happen with cumulative fixed deposits (FDs) on which interest accrues every year and is paid out at maturity.
Loss of compounding benefit
The interest earned on fixed deposits is entirely liable to tax except when specifically exempted. Banks/co-operative societies or post offices deduct TDS at the rate of 10% when the aggregate interest income on all deposits parked with them exceeds ₹40,000 in any financial year.
In case of a senior citizens who are of the age of 60 years or more, interest income above Rs50,000 per annum alone is liable to tax. The threshold for TDS is also Rs50,000 per financial year.
For company deposits, the threshold is Rs5,000 per financial year for all taxpayers.
When TDS is applicable, the money to that extent loses the benefit of compounding. For example, take an investment of ₹10 lakh in a five-year cumulative FD with a bank at 6% per annum interest on an annual compounding basis. The TDS amount of ₹6,000 ( ₹10 lakh x 6% interest x 10% TDS) in the first year loses the benefit of compounding for the remaining tenure of four years. Similar will be the case for TDS in each of the following years. This will lower the expected maturity amount from the FD.
The expected maturity amount on the above FD investment would have been Rs13,38,226. But what the investor receives at maturity will be lower (See table).
While the total tax deducted at source is ₹33,420, the loss due to non-compounding of TDS amount will be Rs4,028.
The loss would have been higher if the interest compounds at lower frequency, that is quarterly/half-yearly/monthly. Also, if PAN is not provided, a higher rate of 20% will be applicable on TDS, which will further lower the maturity amount.
As per Archit Gupta, founder, Clear Tax, the payer deducts the TDS irrespective of the investor’s choice of taxability of the interest income—on cash basis or on accrual basis. For starters, the taxpayer can choose to pay tax on the interest amount either on accrual basis—as and when the bank credits the interest, or on cash basis—on receipt of interest at maturity by the taxpayer.
Avoid TDS impact
If you are a senior citizen and if your total taxable income is lower than the basic exemption limit— ₹3 lakh for individuals from 60 to until 80 years and ₹5 lakh for those 80 years and above—then consider filing Form 15H, a self-declaration form requesting payer not to deduct. The threshold is ₹2.5 lakh in case of an individual under 60 years of age.
Note that these forms must be submitted every year, ideally, at the beginning of a financial year. A few banks such as SBI also allow investors to submit the form online.
Secondly, one can consider spreading the investment across more than one fixed deposit such that the threshold for TDS deduction— ₹40,000/ ₹50,000 interest income per annum in case of bank deposits and ₹5,000 for company deposits—is not breached. For instance, in the above example, splitting the total investment amount of ₹10 lakh into two bank FDs of ₹5 lakh each will not kick in the TDS provision in the whole tenure of five years.
Make sure just to avoid the TDS and its impact on maturity, do not go for deposits that do not suit your risk appetite. If looking at bank FDs exclusively, it is worth noting that each depositor in a bank is insured up to a maximum of ₹5 lakh for both principal and interest amount held.
Further, based on your tenure preference, you can also consider post office schemes that will not attract TDS. These include Public Provident Fund (PPF), Sukanya Samriddhi Yojana (SSY) and National Savings Certificate (NSC), which offer attractive interest rates and no TDS is deducted on the interest earned.
Nishith Baldevdas, founder of Shree Financial and a Sebi-registered investment adviser, says “if an individual is a salaried employee and wants to save for a longer tenure, s/he can also consider enhancing the employee provident fund contribution, which comes under EEE (Exempt- Exempt- Exempt) tax category and does not deduct any TDS on interest income".
Debt mutual funds are another avenue for which TDS is not applicable but generates returns similar/higher to FDs but with market volatility. Baldevdas says “at this juncture, when interest rates are at multi-year low and expected to see an upward trend, investors would be better off not investing in debt mutual funds as it may witness higher volatility".
Among debt mutual funds, however, categories like money market funds have relatively low sensitivity to interest rates. on the interest income earned also lowers the returns? This can happen with cumulative fixed deposits (FDs) on which interest accrues every year and is paid out at maturity.
Loss of compounding benefit
The interest earned on fixed deposits is entirely liable to tax except when specifically exempted. Banks/co-operative societies or post offices deduct TDS at the rate of 10% when the aggregate interest income on all deposits parked with them exceeds ₹40,000 in any financial year.
In case of a senior citizens who are of the age of 60 years or more, interest income above ₹50,000 per annum alone is liable to tax. The threshold for TDS is also ₹50,000 per financial year.
For company deposits, the threshold is ₹5,000 per financial year for all taxpayers.
When TDS is applicable, the money to that extent loses the benefit of compounding. For example, take an investment of ₹10 lakh in a five-year cumulative FD with a bank at 6% per annum interest on an annual compounding basis. The TDS amount of ₹6,000 ( ₹10 lakh x 6% interest x 10% TDS) in the first year loses the benefit of compounding for the remaining tenure of four years. Similar will be the case for TDS in each of the following years. This will lower the expected maturity amount from the FD.
The expected maturity amount on the above FD investment would have been ₹13,38,226. But what the investor receives at maturity will be lower (See table).
While the total tax deducted at source is ₹33,420, the loss due to non-compounding of TDS amount will be ₹4,028.
The loss would have been higher if the interest compounds at lower frequency, that is quarterly/half-yearly/monthly. Also, if PAN is not provided, a higher rate of 20% will be applicable on TDS, which will further lower the maturity amount.
As per Archit Gupta, founder, Clear Tax, the payer deducts the TDS irrespective of the investor’s choice of taxability of the interest income—on cash basis or on accrual basis. For starters, the taxpayer can choose to pay tax on the interest amount either on accrual basis—as and when the bank credits the interest, or on cash basis—on receipt of interest at maturity by the taxpayer.
Avoid TDS impact
If you are a senior citizen and if your total taxable income is lower than the basic exemption limit— ₹3 lakh for individuals from 60 to until 80 years and ₹5 lakh for those 80 years and above—then consider filing Form 15H, a self-declaration form requesting payer not to deduct. The threshold is ₹2.5 lakh in case of an individual under 60 years of age.
Note that these forms must be submitted every year, ideally, at the beginning of a financial year. A few banks such as SBI also allow investors to submit the form online.
Secondly, one can consider spreading the investment across more than one fixed deposit such that the threshold for TDS deduction— ₹40,000/ ₹50,000 interest income per annum in case of bank deposits and ₹5,000 for company deposits—is not breached. For instance, in the above example, splitting the total investment amount of ₹10 lakh into two bank FDs of ₹5 lakh each will not kick in the TDS provision in the whole tenure of five years.
Make sure just to avoid the TDS and its impact on maturity, do not go for deposits that do not suit your risk appetite. If looking at bank FDs exclusively, it is worth noting that each depositor in a bank is insured up to a maximum of ₹5 lakh for both principal and interest amount held.
Further, based on your tenure preference, you can also consider post office schemes that will not attract TDS. These include Public Provident Fund (PPF), Sukanya Samriddhi Yojana (SSY) and National Savings Certificate (NSC), which offer attractive interest rates and no TDS is deducted on the interest earned.
Nishith Baldevdas, founder of Shree Financial and a Sebi-registered investment adviser, says “if an individual is a salaried employee and wants to save for a longer tenure, s/he can also consider enhancing the employee provident fund contribution, which comes under EEE (Exempt- Exempt- Exempt) tax category and does not deduct any TDS on interest income".
Debt mutual funds are another avenue for which TDS is not applicable but generates returns similar/higher to FDs but with market volatility. Baldevdas says “at this juncture, when interest rates are at multi-year low and expected to see an upward trend, investors would be better off not investing in debt mutual funds as it may witness higher volatility".
Among debt mutual funds, however, categories like money market funds have relatively low sensitivity to interest rates.
