Post tax returns of FD rates still below FY24 inflation expectation of 5.4%

Usually, people invest in fixed deposits ( FD) looking at the headline FD interest rates and the comfort of guaranteed returns. However, most of them don't calculate the post-tax FD rates which in most periods (especially for those in higher tax brackets) is not able to beat inflation. Data analysed by FundsIndia shows that even though FD Rates of large banks have increased in the recent past, post-tax returns are still below the fiscal year 2024 inflation expectation of 5.4 per cent. 

Most of the time, it is not possible to beat the retail inflation through bank fixed deposits. However, bank FDs are risk-free and are insured up to Rs 5 lakh per account per person by DICGC.

Currently, the interest rate is around 7.5% p.a. on fixed deposits. For a deposit of Rs 1,00,000, one will earn an interest of Rs 7,500. If the deposit holder is in the slab of 30%, he would need to pay a tax of Rs 2,340 leaving him a net interest of Rs 5,160. This is effectively an interest rate of 5.16%. With the inflation hovering around 5.5%, the effective interest rate of 5.16% doesn't beat the inflation.  

Given the above, the fixed deposits don't offer any significant benefits to taxpayers in 30 per cent or higher slabs.

"Fixed deposits are a great instrument with guaranteed returns and low risk. They offer great benefits for people who want a certainty of return. However, they have never been a great instrument for beating inflation, especially for those in the higher tax bracket. While the interest rates closely track the inflation rates, i.e., the interest rates rise when the inflation increases and vice versa, after considering the tax impact, the net interest earned is always lower than the inflation," said Ankit Jain, Partner, Ved Jain & Associates.

 "Banks are not under pressure to increase FD rates as they are able to comfortably attract deposits from investors despite the lower post-tax returns. The behavioural comfort of investors with guaranteed returns, the simplicity of the product and the safety factor (up to Rs 5 lakhs insured by RBI) works in favour of FDs," said Arun Kumar, VP and Head of Research, FundsIndia.

 

 Investors can opt for A-rated corporate bonds 

A-rated corporate bonds:  Many A-rated corporate bonds can provide a 10-11% annual yield compared to 7-8% annual interest on FD.

"If an investor in the 30% tax bracket invests Rs 10 lakh in a bank FD that fetches 8% per annum interest, her earnings would be Rs 80,000. Post-tax, the earnings will further reduce to Rs 56,000. If she invests the same money in an A-rated corporate bond that yields 10% annual coupons, she can earn Rs 1 lakh at the end of the year, and her post-tax earning would be Rs 70,000. Thus, she can earn Rs 14,000 as her risk premium. However, corporate bonds are illiquid and bear credit and interest rate risk. Thus, a retail investor should not use them as a replacement for emergency funds or any other short-term needs," said Ajinkya Kulkarni, Co-Founder and CEO, of Wint Wealth.

Other options as per Jain

Debt-based mutual funds - If a person is looking to invest long term, then these provide the benefit that the tax is not levied on the growth of the mutual funds. Tax is only payable when the funds are redeemed, on account of which the growth is higher. However, one should be aware that they don't offer certainty of interest. 

 Equity arbitrage mutual funds - These funds offer slightly lower interest rates but the tax rate of such funds is lower. Tax is levied only at 10 per cent if the funds are held for a period of more than one year. In other cases, the tax is levied at 15 per cent. Like debt mutual funds, tax is only payable when the funds are redeemed and not with the growth every year. These also don't offer certainty of interest. 

 Tax free bonds - One can also purchase tax-free bonds which are offered by various public sector organisations. The interest rate is lower but after considering the tax impact, the returns are much better. These are especially beneficial for people who are in the highest tax slab of 43% and offer a fixed rate of interest. However, they need to be purchased from the secondary market.