FD vs Debt Mutual Funds: Understanding the Changes in Tax Benefits for Debt Mutual Funds

May 13, 2023
Fixed Deposits (FD) and Debt Mutual Funds are popular investment options for individuals who want to earn fixed income. However, recent changes in tax regulations have affected the tax benefits associated with debt mutual funds. In this comparison, we explore the key differences between FDs and debt mutual funds, keeping in mind the changed tax landscape.

Returns: FD: Fixed deposits offer a predetermined rate of interest for a specified period, which ensures a fixed return on investment. Accumulated interest is taxed according to the individual tax schedule. Debt Mutual Funds: Debt mutual funds invest in fixed income securities such as government bonds, corporate bonds and money market instruments. The performance of debt mutual funds is not fixed and depends on the performance of the underlying securities. Profits from the investment are classified as either short-term or long-term capital gains, which are taxed differently. Liquidity: FD: Fixed deposits usually come with a predetermined lock-in period during which early withdrawals may incur penalties. Liquidity is limited until the maturity of the deposit. Debt Mutual Funds: Debt Mutual Funds offer more liquidity as compared to FDs. Investors can partially or fully redeem their investment according to their needs according to the exit load and redemption rules of the fund.

Risk: FD: Fixed deposits are considered low-risk investments because they offer fixed returns and are guaranteed by the depository institution. The risk of losing capital is minimal, especially if you invest in reputable banks. Debt Mutual Funds: Debt mutual funds are exposed to market risks related to changes in interest rates, credit ratings and developments in the underlying securities. Although the risk is relatively higher compared to FDs, the risk profile may vary depending on the types of securities held in the fund.

Tax benefits (before recent changes): FDs: Interest earned on FDs is taxable as per individual tax table. But under section 80TTB, pensioners were entitled to a tax benefit of up to Rs. 50,000 FD from interest income. Debt mutual funds: Earlier, debt mutual funds held for more than three years were eligible for indexation benefits, which reduced the tax liability on long-term capital gains. That made debt mutual funds more efficient for investors in higher tax brackets. Changes in tax benefits for debt mutual funds: 2021-2022 With the introduction of the Union budget in 2016, allowances for indexation of long-term capital gains of debt mutual funds were excluded. Long-term capital gains on debt mutual funds are now taxed at a flat rate of 20% and index benefits no longer apply.

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