10 Common Myths About Fixed Deposits and Interest Earned
Fixed deposits, also called term deposits, are one of the most traditional investment options. While we may hear a lot of buzz around mutual fund SIPs, liquid, balanced and debt funds, stock picks, tax-free bonds, PPF, EPF, etc., the fact is that nothing can beat the confidence and simplicity of the fixed Deposit. Although they are tax inefficient and not the best return provider, fixed deposits deserve their own pie in your portfolio. Tell me if there is any other investment option you know that is as simple, guaranteed, liquid, monitoring-free and risk-free – all rolled into one – as a fixed deposit? Actually, there isn’t one. This does come at the cost of tax inefficiencies and slightly lower returns, but in many cases, returns may not be the only criteria for deciding on your investments.
So, if you’ve started feeling happy that all that chunk of fixed deposits lying almost unattended in your bank accounts is now justified, let me throw in a word of caution here. Your fixed deposit earns interest. The bank may also deduct some tax (TDS). But you may incur more taxes. And if you haven’t been paying that, you could be in big trouble. Yes, at the time of filing your income tax returns, you are required to calculate the additional tax you have to pay on your fixed deposit interest – and then pay it too. This may be completely over and above the TDS that the banks may have deducted. If you’ve overlooked this, then I’m sure you also understand that ignorance of the law is never an excuse. Inefficiently managed interest accrued from your bank fixed deposits can actually land you in serious tax trouble.
Let’s dispel some of the common myths surrounding fixed deposits and the interest accrued on them:
Myth 1
The interest on the fixed deposit is hidden from the tax authorities
Fact 1
All banks report to the IT department the accrued interest against your PAN number. So, gone are those days when banks and their branches were shut down. Today, in this interconnected world of PAN and Adhaar, there is no way to escape the prying eyes of the tax officer.
Myth 2
The bank has already deducted the TDS – so you don’t need to pay any more tax
Fact 2
Banks deduct only 10% of the interest earned as TDS or 20% if you have not provided the PAN number to the bank. But you may actually be responsible for more. It all depends on your total income in the financial year. If you fall in the 30% tax bracket, then you are liable to pay 30% tax on the interest earned on fixed deposits – after adjusting for the 10% or 20% TDS that may have already been deducted by the bank. If you are in 20% tax bracket and the bank has deducted only 10% TDS, then you are liable to pay another 10% tax on the interest earned.
Myth 3
You have filed Form 15G/H – so no tax liability
Fact 3
Form 15G/H has a very specific purpose where you are confirming to the bank that you are not likely to fall even in the 10% tax bracket in the current financial year – and hence you are asking the bank not to deduct TDS. But if this does not prove to be true by the end of the financial year, you have to pay tax as per the tax slab in which you fall.
Myth 4
Your interest is below Rs 10,000 per financial year and hence no tax liability
Fact 4
Even 1 INR interest earned on fixed deposits is taxable unless of course you fall in 0% tax bracket. This release of Rs. 10,000 is not applicable on fixed deposit interest. This exemption is only available for interest earned on money sitting idle in your savings account. So you are taxable even if your interest income is below INR 10,000. The only advantage you have is that the bank will not deduct TDS until the interest crosses INR 10,000. Even if this is the case, you will have to pay the applicable tax at the time of filing the ITR.
Myth 5
I have a recurring deposit. Here the interest is not taxed
Fact 5
100% incorrect. Be it FD or RD, every single rupee of interest earned is taxed as per your current tax rate
Myth 6
I have invested in a 5 year tax free FD. Now it will not be taxed
Fact 6
Contrary to its name, Tax Free FDs are actually NOT tax free. Yes, they do not help you save tax on your interest earned from the fixed deposit. They really help you save tax by showing the principal investment under section 80C, just like you can save tax by showing EPF or PPF investment under section 80C. However, every single rupee of interest is taxable like any normal fixed deposit.
Myth 7
National Savings Certificates (NSC) or Kisan Vikas Patras (KVP) are tax free
Fact 7
Again, none of this is true and every single rupee of interest is taxable like any normal fixed deposit.
Myth 8
The Pensioners Deposit Scheme is tax free
Fact 8
Again, none of this is true and every single rupee of interest is taxable like any normal fixed deposit.
Myth 9
I have invested in FD in my wife’s name. So I am saved from any taxes.
Fact 9
Money gifted to a spouse does not attract taxes. But if this money is invested, the income generated by it is merged with the donor’s income and taxed accordingly. If the husband has invested in fixed deposits in the name of his wife, the interest will be taxed as his income. So better avoid wasting time and effort.
Myth 10
I have invested in my child’s name. So I am saved from any taxes.
Fact 10
Money gifted to a child does not attract taxes. But if this money is invested in the name of a minor child, the income generated by it is merged with the donor’s income and taxed accordingly. If a father has invested in fixed deposits in the name of his minor child, the interest will be taxed as his income. So better avoid wasting time and effort. However, in case of children, there is a small exemption of Rs 1,500 per year per child for a maximum of two children.
Calculate the tax payable on the FD interest
1. Calculate your total interest income from all fixed deposits for a financial year. Let’s say it’s INR 50,000
2. Find your tax rate (based on your total income – which includes all sources of income including FD). say it’s 20%
3. Based on 1 and 2 above, calculate the tax payable on the FD interest. This will be 20% of 50,000 = 10,000 INR
4. Check Form 26AS to see the TDS already deducted. Assuming it is deducted at the standard rate of 10%, it will be INR 5000
5. Additional tax payable at the time of filing ITR = INR 10,000 (as per 3) – INR 5,000 (as per 4) = INR 5,000
How do I file interest income tax?
Report the total interest as “Income from other sources”
In the ITR form, it will be added to your total income and taxed as per the tax slab in which you will fall.
Avoid trying to be clever with the IT department
In today’s interconnected banking system, avoid the following, play it safe and live a peaceful life:
1. Don’t try to file Form 15G/H just to avoid TDS. Making a false declaration can be considered a very serious crime – which can even lead to up to 2 years in prison. This information makes its way to the person’s Form 26AS. One can only imagine what will happen to an investor whose Form 26AS shows filing of Form 15G or 15H in multiple banks and income that exceeds the basic exemption limit. In any case, even if you can avoid TDS from the bank, you are required to calculate and pay the total tax while filing ITR. Playing such games is simply not worth the effort.
2. Don’t waste your time and energy in splitting your bank FDs across multiple banks or branches. Each account is linked through your PAN number.
3. Avoid trying to save taxes by investing in the name of your spouse or minor children. There is a clubbing income provision which results in any interest earned by your spouse or child being lumped with your income and taxed accordingly. In some cases, it may help to invest in your parents’ name as the clubbing provision does not apply there. However, just make sure that the parents’ income and tax liability should not increase because of this.
Having a clear understanding of fixed deposits and the tax liabilities arising from interest income from them will keep this investment option the way it was designed – simple, guaranteed, liquid, monitoring-free and risk-free. Then you will be able to enjoy its true charm!
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