Are You Getting Optimum Returns On your Fixed Deposits ?

Update:As per finance bill FY 15, the exemption limit of Rs. 10,000 on deposits will be per bank basis and not per branch basis.


Many people book theirs FDs just by considering a suitable combination of interest rate and the tenure, but little do they know that there are 2 more factors that determine the final return.

(1) Tax Deduction at Source or TDS

The first factor is TDS or Tax Deduction at Source- A bank branch shall deduct the TDS @ 10 % when accumulated interest exceeds Rs. 10,000.

This tax deduction not only reduces your interest amount but also deprives you of future return on it. This TDS erodes a significant amount especially when the tenure of the FD is a longer one.

Let us understand it with an illustration-

An FD (with quarterly compounding option) of Rs. 5,00,000 with a coupon rate of 10 % for a tenure of 5 years, matures to an amount of Rs. 8,19,308 but when TDS is deducted maturity amount reduces to Rs. 7,80,255. 

The difference in these two maturity values is Rs. 39,053 but the total tax deducted or TDS is Rs. 31,139 only.

This means Tax deduction deprives you a return of Rs. 7,914 Rs. (39,053-31,139).

To save the TDS one has to submit the form 15 G (15 H in case of senior citizens).

But this option is available to investors whose income don’t exceed basic income tax exemption limit.

So, what investors who are not eligible to submit these forms should do?

They can save the TDS by judicious money management using internet banking (and this is 100 % legal). I have discussed this in detail here.

(2) Compounding Option

If you don't need money then never ever choose the Interest Payment option but instead opt for Reinvestment of the Interest. Banks generally compound the interest quarterly.

Let's see an illustration-

Mr. Sharma opens an FD account with a tenure of 5 years for a principal of Rs. 5 lakh (.5 million) at a coupon rate of 10 % and opts for a Quarterly Interest Payment. 

Mr. Verma too goes for a similar FD but chooses Quarterly Interest Compounding option.

After 5 years, Mr. Sharma gets a total interest of Rs. 3,14,123 Rs. (including saving Interest on the FD interest) while Mr. Verma gets a total interest of  Rs. 3,19,308 (Rs. 5,185 more than Mr. Sharma).

Simply put, the interest earned by the FD fetches Mr. Sharma a meagre 4 % saving bank interest return while the same in case of Mr. Verma fetches 10 % FD return.

So, moral is, if you don't need the money then you should always choose the Interest Reinvestment option for your FD.

PS: Having read this article a person commented-

Sorry mate this is terrible advice. If income from FD falls above taxable limits the entire income is taxable. Even if you open multiple FDs to ensure no TDS you still need to pay up what you owe.

and answer to his concern is-

This article does not say how you can save the income tax but rather emphasizes on  how 'tax deduction' reduces your returns and by saving  this 'tax deduction' how you can optimize your returns.
Saving the TDS does not mean tax exemption.

Hope it helps.

Things you should know before opening a bank Fixed Deposit

Update:As per finance bill FY 15, the exemption limit of Rs. 10,000 on deposits will be per bank basis and not per branch basis.

Gone are the days when investors used to get benefits of section 80 L, where interest earned up to Rs. 12,000 was exempted.
Now, with 80L benefits gone away, investor should be aware of TDS (Tax Deduction at Source).

Whenever your Fixed Deposit earns you more than 10,000 Rs. per year you are liable for 10% TDS deduction.In case of non availability of PAN, TDS shall be deducted at the rate of 20%.
To prevent bank from deducting TDS either form 15 G Or 15 H, needs to be submitted.

15 G form is for investors with age bellow 65 years, provided investors’ income is bellow tax exception income (presently 1, 80,000, which is supposed to become 2, 00,000 with implementation 'Direct Tax Code').
Senior citizens (with age above 65) need to submit 15 H form, provided they too fall in tax exemption income (presently Rs.2, 50,000).Tax exemption income for Senior citizens above 80 is Rs. 5, 00,000.

You shall ask me, what to do, when one is not eligible for either 15 G or 15 H.

Just chill, you have to take benefit of efficient money management.

Instead of booking a lump sum amount of FD, investor should book smaller FD’s with different banks or different branches of the same bank.As TDS is deducted at branch level, booking FD’ s with different branches of the same bank, taking care that interest earned on each FD does not exceed Rs.10,000 limit.

Suppose, Mr. Chitnis has to invest Rs. 10 lakhs in FD offering 9.25 % per annum of interest rate and he is not ready for TDS deduction.Mr. Chitins needs to make 10 FDs of Rs. 1 lakh each with different branches of a bank, so that each FD shall earn interest of Rs. 9575.83(annual return with quarterly compounding), which falls well below tax-exemption limit of Rs. 10,000.

And this is not impractical with the help of net banking, where investors can choose any branch across various Indian cities to book FDs.

PS: Saving the TDS does not mean tax exemption. 
Investors need to show the  interest (accrued or earned) in their IT returns. 

FMP- an alternative to FD

FMP(Fixed Maturity Plan) is similar to FD(Fixed Deposit) schemes offered by banks and other companies but unlike FD  returns on FMP  are not assured.

Though  returns of FMP are not assured but actual return does not vary significantly.

FMPs are debt instruments and the corpus is invested in fixed income securities like Commercial Papers(CPs), Certificates of Deposits(CDs), money market instruments and corporate bonds.

Depending on the tenure of FMP, the Fund manager invests in one or combination of aforesaid instruments of similar maturity.

The yield on resultant yields of invested instruments, subtracted by the expenses incurred, gives the indicative returns.

Expense incurred, better called as the expense ratio  varies from .25 to 1%.

FMPs are close ended debt funds and maturity horizon varies from 1 month to 5 years. Minimum investment in FMP starts from as low as 5000 rupees.

Redemption:

Nowadays no entry load is applicable and as FMPs can’t be redeemed before maturity there is no question of  the exit load.

As these schemes are listed on  exchanges, investor can sell FMP on the exchange before maturity date, but presently there is very little liquidity.

Tax Implication:

Unlike FD, there is no deduction of TDS on FMP investment.

FMPs are more tax efficient than FDs.

Interest received on FDs is categorized as ‘income from other sources’.

And added to the income of the investor and taxed according to the slab investor falls in.

If FMP with growth option and maturity period more than 1 year , investor gets the indexation benefit and 20%  capital gain tax is payable (10% without indexation).

In case of FMP (growth option) and maturity period less than a year, short term capital gain is added to the investor’s income and taxed according to the tax slab in which investor falls in.

In both above cases, investing in FMP is beneficial for the investor who falls in the 30% IT tax bracket.

In case of FMP with dividend option, dividend is tax free in the hands of the investor, but fund house needs to pay the DDT (Dividend distribution Tax).

In higher interest regime FMP gives better post tax returns than FD’s

Why FMPs are riskier?

As FMPs invests in unsecure money market instruments such as commercial paper, more risk is associated with it.

Who should go for it?

FMP is suitable for investors with little more risk appetite, expecting better post-tax returns than FDs. 

FMP is more suitable for the investor falling in the top tax bracket.

Investors should go for high rated FMPs only.