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What are the post-tax returns on an FD?

Traditional investment and saving options such as fixed deposits (FD) continue to remain popular with investors. However, there is one aspect that many investors, especially those falling within higher tax slabs, fail to look at. The interest income that one earns through fixed deposits is taxable according to one’s income tax slab. As a result, the post-tax returns are relatively low.

Fixed deposits give you a fixed interest either annually or on a cumulative basis. What is important here is that this interest income is taxed on an accrual basis. The interest that one earns on their fixed deposit gets added to the person’s income and is taxed in accordance with the income slab. As a result, this tends to reduce post-tax returns, especially of those who fall under the highest tax bracket.

Bank will deduct the tax at source (Tax deduction at source – TDS) before paying the interest to the investor if the interest incurred exceeds ₹10,000 in a financial year. If PAN card information has been provided, TDS is deducted at 10%. If PAN card information has not been provided, TDS is deducted at 20%. 

Often, taxpayers forget to count income from a fixed deposit as a part of their overall taxable income and forget to pay the tax liability on the same above and beyond the TDS. In such instances, taxpayers are liable to be served with a notice from the income tax department 

In general, investors need to evaluate if post-tax returns are beating inflation. Investors in the 30% tax bracket may find that their post-tax returns on FDs may not be sufficient to beat inflation. The implication of this is that the people in the lower tax bracket tend to gain more in terms of the returns that they receive from the FDs as compared to those whose income goes into the higher tax slabs. Here is an illustration: 

Tax slab (%)Amount invested (₹)Interest (₹)Tax (₹)Net Interest Earned (₹)Post-tax Return (%)
10% 2,00,000 18,000 1,854 16,146 8.07%
20% 2,00,000 18,000 3,708 14,292 7.14%
30% 2,00,000 18,000 5,562 12,438 6.21%

In the above illustration, we can see that the return on fixed deposits for those individuals in the higher tax bracket of 30% is only 6.21%. As compared to this, a person in the lowest tax slab is able to fetch a return of 8% on the same investment post taxation.

Hence, it’s essential to look at post-tax earnings and not just the interest rate to see whether investing in FD will actually match your return expectations.

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