The interest rates offered by large banks such as SBI, HDFC, ICICI among others on term deposits of 3 to 5 years vary from 5% to 5.3%. Fares for seniors are 20 to 60 basis points higher. These are the lowest interest rates in almost two decades. On the other hand, inflation hovered around 5-6%.

“Interest rates in India and most major economies are at historically low levels due to actions taken by global central banks, including the RBI, to support economic growth in the aftermath of the pandemic. Thanks to a combination of these monetary measures and budgetary support provided by governments, economic growth has rebounded relatively well, which has raised inflationary concerns, ”said Dhaval Kapadia, director of managed portfolios, Morningstar Investment Advisers India.

In addition, investors often ignore the impact of tax on final yields on term deposits. Interest on term deposits is fully taxable, which means the higher the tax bracket, the lower the return.

Let’s understand the impact of taxation and inflation on FD yields with an example.

For an investor in the 30% tax slab (without cessation and overcost), a 3-year FD with an interest rate of 5.5% will yield 3.79% after tax. Now, given that Consumer Price Index (CPI) inflation is set at 5.3% for FY 22 by the RBI, the actual return for the FD is basically around -0.9%.

In a research paper released last month, the SBI suggested it was time to review the taxation of interest on bank deposits, with the real rate of return on bank deposits remaining negative “for a considerable period”. Until then, experts recommend that investors look at other low-risk fixed income instruments and debt products that are tax-efficient and capable of generating better returns than term deposits.

Think about tax before filing

Prableen Bajpai, founder of FinFix Research and Analytics, said choosing investment options for small economies based on one’s taxation can make a big difference in an investor’s final returns.

For example, the Post Office Term Deposit and National Savings Certificate (NSC) offer a slightly higher interest rate of 100 to 120 basis points compared to FDs. However, the tax treatment of interest for both options is the same as for FD.

Deduction up to ??1.5 lakh on a deposit can be claimed under section 80C for NSC and 5 year deposit. For this reason, most postal savings plans are not much different from FDs for the highest tax brackets.

As a general rule, investors in the highest tax brackets should avoid products where taxation is at the level of the income tax slab, Bajpai said.

She suggested that investors should look beyond fixed income products for better tax-efficient products. “Generally speaking, a combination of arbitrage funds and debt mutual funds can work for investors in the higher income bracket. While arbitrage funds offer equity taxation, debt funds offer an indexation advantage if held for three years. “

Debt funds are the best bet for a long term horizon

Debt mutual funds are a clear winner among all debt investing options for a longer tax time horizon, according to financial planners.

In the case of debt funds held for more than three years, the indexation advantage considerably reduces the tax. Long-term capital gains on debt funds are taxed at 20% with indexation, which increases the purchase price after accounting for inflation during the holding period. This reduces the effective tax to 6-7%. Short-term capital gains on debt funds are taxed at tax slabs.

“Investors subject to higher taxes may consider debt funds in categories such as banks and PSUs, corporate bonds, and medium to long term funds where yields are slightly higher than FDs and the returns would be subject to lower tax rates for three-year holding periods. and above, ”Kapadia said.

Debt funds are able to generate higher returns than traditional fixed income instruments; however, investors should note that they carry risk, albeit low, as they are linked to the market.

Even if the low interest rate regime is proving difficult for investors seeking security, one cannot turn to risky instruments in search of returns, said Suresh Sadagopan, Managing Director and CEO of Ladder7 Wealth Planners.

Seniors most affected

Seniors feel the negative real returns from the DF the most, as most of them place the bulk of their retirement funds in the DF and depend on the interest income they generate for their regular expenses.

Santosh Joseph, Founder and Managing Partner of Germinate Investor Services LLP, said it’s time for seniors to look beyond DFs and consider spreading their retirement funds over fixed income, low-risk investment options. .

“They can use government-backed programs like the Senior Citizen Saving Scheme (SCSS) and Pradhan Mantri Vaya Vandana Yojana (PMVVY) to get better results.”

Currently, SCSS gets the highest interest rate among any government-backed programs at 7.4%. The plan ensures a steady stream of retirement income since the interest amount is paid quarterly to the account holder. Although interest on SCSS is fully taxable and also subject to TDS, the principal is available for tax deduction up to ??1.5 lakh under section 80C.

PMVVY comes with a 10 year longer lockout. The biggest advantage is that the scheme offers a guaranteed pension to retirees based on a rate set when the scheme is started. The interest rate on PMVVY is revised annually by Life Insurance Corporation of India (LIC), with the rate for the current year set at 7.4%.

Another option is the Reserve Bank of India floating rate bonds, which currently offer a yield of 7.15%. Interest is paid every six months and is not cumulative.

“Those with higher income can use the systematic debt withdrawal plan (SWP) tool to reduce taxes payable. Investors looking to manage household investments with their corpus of requirements should have 10-25% of the portfolio (as the case may be) in equity-focused products to ensure some growth of the corpus for the next decades, ”said Bajpai.