Falling interest rates and changes do changed the rules fixed income Scenario in the last 2-3 years. five year Fixed deposit SBI rate has dropped from 6.85% at the end of 2018 to 5.40% now. But the interest from fixed deposits is fully taxable, and the after-tax return in the 30% tax bracket is a modest 3.7% which exceeds consumer inflation by 130 basis points in urban areas.
other loan The alternatives have also given muted returns. Except credit risk funds, all categories of debt funds have given 4-6% returns in the last one year. “Fixed income investors need to revise their return expectations. “They should not expect returns from debt investments 2-3 years back,” says Raghavendra Nath, managing director, Ladderup Wealth Management.
How does it affect the tax return?
This week’s cover story looks at various fixed income option investors and examines their usefulness to investors. Financial planner Pankaj Malde says, “The investment option will completely depend on how quickly you need the money. We have created four broad categories of financial goals based on investment horizon.
Very short duration: 3-6 months
If you have a large amount of cash (property sale or mature investment) and need to redeploy it in 3-6 months, keep the money in a fixed deposit or liquid fund. The returns won’t be much, but that shouldn’t be a concern. When the investment horizon is so small, the focus should be on capital safety and liquidity and not on returns. Even if the returns are 1-2 percentage points higher, it won’t make a big impact in 3-6 months.
In fact, if your bank offers a higher rate on savings account balances, you might even consider keeping money in your bank account. Some banks including Kotak Mahindra Bank, IndusInd Bank, Bandhan Bank, Lakshmi Vilas Bank and RBL Bank offer 6-6.5% interest on savings bank account balance if the amount exceeds a certain limit. Under section 80TTA, interest up to Rs 10,000 on savings bank balance is tax free. This will bring down the overall tax on interest earned from your bank balance.
Another option can be liquid funds and ultra short duration debt funds. Government bond yields have risen in recent months and could rise further if inflation picks up. But these funds will not be impacted as they have very short duration instruments.
Arbitrage funds can be a good option for those who are more focused on reducing tax. This category has given 4.18% return in the last one year, which is at par with the returns of debt fund category. But these arbitrage funds are treated as equity funds for tax purposes, which means that short-term gains will be taxed at 15%.
When do you need money?
The time horizon will define which instrument is suitable for you.
Short Term: 1-2 years
If your investment horizon is slightly longer in 1-2 years then the investment options will not change much. You can also consider corporate fixed deposits, where the interest rates are slightly higher than what banks offer. But keep in mind that corporate deposits are not as safe as bank deposits. You still need to be careful when Investment in bank deposits. “Limit your investment to Rs 5 lakh per bank so that your investments are covered under the deposit insurance scheme,” said Mrin Agarwal, Founder Director, Finsafe India.
Investing in short term debt funds would also be a good idea. The benchmark 10-year government bond yield, which stood at around 6% for most of this year, has already risen to 6.34% and is expected to rise further. “Do not invest in medium term and long term bond funds at this time,” says Malde. However, funds holding short-term bonds will not be impacted.
Arbitrage funds can prove to be very useful if the holding period is one year or more. Since these schemes are treated as equity funds by the taxpayer, profits up to Rs 1 lakh will be tax free.
Medium term: 3-5 years
Your options increase if you can stay invested for more than three years. For one, if the holding period is three years or more, gains from debt funds are treated as long-term capital gains. They are taxed at 20% after indexation, not at the slab rate. Indexation takes into account consumer inflation during the holding period and accordingly increases the purchase price of the asset to adjust for inflation. So if you bought a property three years ago for Rs 10,000 and the cost inflation index has risen by 10% since then, the property will be considered to have been bought for Rs 11,000. “High inflation is here to stay for some time, which means indexation can significantly reduce the effective tax,” says Sandeep Bhalla, a Mumbai-based financial advisor and former banker.
If you are willing to wait for five years, you can also consider post office schemes like National Saving Certificate, Kisan Vikas Patra and Monthly Income Scheme. These small savings schemes pay higher interest than bank deposits while the sovereign guarantee makes them completely safe. The problem is that they are not very flexible. NSC cannot be closed, however Kisan Vikas Patra can be sold after 30 months. Senior citizens (above 60 years) can consider the Senior Citizens Savings Scheme, which pays 7.4% returns and interest every quarter.
Long term: more than 6-7 years
Till last year, Employees’ Provident Fund was the best long-term investment in loans. Employees covered under the scheme can withdraw a major part of their salary to earn 8.5% tax free return. But this year’s budget has changed the rules and reduced the glare of provident funds. Now, interest earned on employee’s contribution above Rs 2.5 lakh will be taxed. Still, experts say that PF is the best long-term option and one should definitely do away with the Rs 2.5 lakh limit for tax-free contributions to the scheme.
PPF is another tax-free option that can be considered. At 7.1%, it is far better than other small savings schemes and bank deposits. But its annual investment limit is Rs 1.5 lakh. If you have already exhausted that limit, you can consider RBI’s floating rate saving bonds, which are currently offering 7.15%. These bonds have a maturity of seven years and the interest rate is 35 basis points higher than the rate offered on National Savings Certificates.
If you want to save for your daughter, choose the Sukanya scheme, which offers 7.6% tax free interest. But it is only open to girls under the age of 10.