Today, if you are a High Net-Worth Individual (HNI) with Fixed deposits exceeding one crore and falling in the high tax bracket above 25%, you have better options that are tax-efficient with the same level of safety. While Fixed Deposits seem like a convenient and ideal investment option, their post-tax net returns often fall below the inflation rate. Also, Debt Mutual funds, which are equally safe and give approximately similar returns, have an edge as they offer better after tax returns. Example given below :
- Fixed Deposits: Returns are taxed on an accrual basis at the investor’s tax slabs. So even if you don’t redeem, you are liable to pay taxes every year.
- Debt Mutual Funds: Returns are taxed upon redemption under the Capital Gains Tax.
Comparison of FD and Debt Mutual fund 3 years post tax return
| Investment | Marginal Tax Rate * | Tax Rate (Debt- LTCG) | FD Return | Debt Return Compounded | Holding Period |
| 10,000,000 | 39% | 12.50% | 7% | 7% | 3 years |
FD income tax are accrual basis , they are taxed every year as per income tax slab rate @39% for HNI
| 1st year | 2nd Year | 3rd year | Total | |
| Investment (FD) | 10,000,000 | |||
| Interest Accrued | ₹700,000 | ₹700,000 | ₹700,000 | ₹2,100,000 |
| Tax Paid | ₹273,000 | ₹273,000 | ₹273,000 | ₹819,000 |
| Net return | ₹427,000 | ₹427,000 | ₹427,000 | ₹1,281,000 |
| 3 years- Post Tax Absolute Return | 12.81% |
*Tax Rate- Income Tax Slab Rate for HNI @39%
Debt mutual funds are taxed only at redemption on capital gains @12.5 %
| Investment (Debt) | 10,000,000.00 |
| Interest Accrued over 3 years period (XIRR) | ₹2,250,430.00 |
| Total | ₹12,250,430.00 |
| Tax | ₹281,303.75 |
| Net Return | ₹1,969,126.25 |
| 3 years- Pre-Tax Absolute Return if not redeemed | 22.50% |
| 3 years- Post Tax Absolute Return if redeemed | 19.69% |
Conclusion : Debt Mutual funds provide better absolute long term net return 19.69% over 3 years as compare to 12.81% on Fixed Deposits.
Debt Mutual funds provide Tax efficiency. They provide better net returns than Bank FD and Corporate FD.
- It is more Liquid and can be redeemed overnight as compare to FD premature withdrawals.
- A Debt Mutual fund can be partially withdrawn and be taxed on redemption only, whereas in FD, you are taxed on the full amount of interest accrued.
- There are different types of Debt Mutual Funds like : Liquid fund, Ultra Short term fund, Medium Duration Fund, Long term fund, Arbitrage fund, Equity saving fund etc based on the risk profile and the time period funds can be allocated.
- Corporates having surplus cash park their money in debt mutual funds. Example:
- Bajaj Finance: ~ 5247 Cr
- Titan : ~1600 Cr
- Infosys : ~1913 Cr
We at Simplicity Investing too park our surplus funds in these Short term Debt Mutual funds, which offers better options for tax optimization with safety and liquidity.
