Mutual Funds have many Tax Advantages over Bank Fixed Deposit

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And money deposit in the bank is good thing but we need to see that this money saves or rather losing it? In this article, you see how mutual funds give tax advantages with less taxation. So here is detailed explanation of entire method.

Interest rates on FD and Mutual fund

This is an important aspect while choosing between mutual funds and fixed deposits. For mutual fund, tax status depends on category of mutual fund, equity or debt. In three years, falling interest rates have hit around 40% from annual income as compared to return of fixed deposit. Each step is turn down of FD rates appears small and there is 0.25% to 0.5% rate which sounds small.

For instance, if interest rates have fallen from 7.5% to 7% in income that deposits make. From past three years, you have seen 2.5% decline in rate of interest that you earn from your FDs, from 8.75% to 6.25%. Over past years, you have seen falling rates regime in fixed deposit so you can shift your money from fixed deposits to mutual funds.

See Income Tax Implications of Bank FDs Vs Mutual Funds 

Risk Profile

Mutual funds have low risk profile would appeal to FD holders. These have rates of return that appear high than fixed income. However, you can calculate in same way as in above example. While interest rate offered on bank FDs are fixed for entire tenure but returns on mutual funds vary based on market movement. Hence, mutual funds investments are on market risks.

So you can see your risk appetite while opting between bank’s fixed deposits and mutual funds. Mutual funds unlike, bank FDs do not come with insurance and credit guarantee. Over same period, an average liquid fund has slight risk and have 7.5% yielded but has 10% higher in terms of earnings. Must Read how one-time investment in ELSS is better than SIP?

Mutual Funds vs. Fixed deposits

Although returns of mutual funds are not guaranteed you have done your homework. Based on your financial goals, risk-taking appetite and timing you can invest to get profitable returns for you. But first you need to understand taxation before investing in mutual fund or FD.

In addition to this, if you investments less than three years then taxation is same to both mutual funds and fixed deposit. If you look for selling entire mutual fund, earnings will always be taxed on same way as FD that is added to your income.

However, your investment goal is to take capital gains from your mutual fund so in that case, tax paid on mutual funds will be less. Now let’s do some math in order to understand tax treatment of mutual funds.

You can also read Top 5 Best ELSS Funds for FY 2017-18  

Tax Implications of Investing in Mutual Funds

For example, let say you invest Rs 10 lakh in mutual fund. After year, mutual fund value has increased to Rs 10.8 lakh. Now, you want to withdraw Rs 80,000 you have gained. Note that out of investment you hold 7.4% is gain and 92.6% is principal that you had invested in mutual fund.

When you withdraw any money you think that withdrawal is consist of gains and principal in same proportion for tax purposes. Therefore, out of Rs.80, 000 you consider Rs.5, 926 gains only and it will add to your taxable income. In FD if you pay Rs 24,720 as tax in high slab and in mutual fund you have to pay Rs 1,831 as tax.

Benefits in FD and MF

There are other benefits which you need to understand before investing in funds. There is TDS and annual taxation and for cumulative FDs you have to pay tax every year.  And that money you will not earn returns in future. In mutual fund investment there is no annual tax liability because gains are not allowing for income.

So money is available for compounding as long as investment you have. After three years, amount add in mutual fund will be more in deposit so you are in top tax bracket.

Taxation of Investing in Fixed Deposit

Interest income earned from bank fixed deposits is fully taxable and you will get income tax exemption on interest earned up to Rs. 10,000 year. And interest received on fixed deposits is added along with other income and you have to pay tax on that income at an interest rate applicable to you.

In case of bank fixed deposits, banks deduct tax at source (TDS) at rate of 10 per cent if interest income for year is more than Rs. 10,000. TDS is calculated by checking the combined interest income of all branches of a particular bank.

If you invest of Rs 1 lakh in FD at end of three years FD value will be Rs 1.26 lakh while fund investment value is Rs 1.4 lakh. Since FD tax split between 10% TDS and rest paid out directly. And exact rate of return depends on how you account for this tax.

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