Fixed deposits may offer better returns if banks raise interest rates following a Reserve Bank of India (RBI) repo rate hike, but higher rates do not necessarily translate into better post-tax gains. Since FD interest is taxed at an investor's applicable income tax slab, inflation and taxes can significantly reduce the actual returns, particularly for high-income earners.Subsequently, leading banks in India are expected to soon revise their FD rates, offering higher returns to investors. But is that enough?
Traditionally, FDs are considered conservative investment tools that offer modest but guaranteed returns. As a result, many people opt for these financial products for their near-term investment needs.
But interest earned on FD is added to your total income and taxed at the slab rate. This means that if you are a high earning professional, tax can eat into a lot of gains for you. Combined with the impact of inflation, you may end up gaining very little returns from your FDs.
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Here's The Math:
Assuming that two people invest Rs 2 lakh in FD for three years at 7% per annum (quarterly compounding).
FD Growth:
Year | Interest accrued |
Year 1 | Rs 14,372 |
Year 2 | Rs 15,404 |
Year 3 | Rs 16,512 |
Total | Rs 46,288 (maturity ≈ Rs 2,46,288) |
Example 1: Rs 20 lakh income
At Rs 20 lakh, you are at the top of the 20% income tax slab in the new regime. Every rupee of FD interest falls into the 25% slab:
- Tax on Rs 46,288 interest: Rs 12,035
- Interest left after tax: Rs 34,253
- Effective post-tax return: 5.4% a year
Assuming 5% inflation, your real return is negligible.
Example 2: Rs 8 lakh income
Taxable income stays below Rs 12 lakh even after adding the interest, so the Section 87A rebate wipes out the entire tax.
- Tax on interest: Rs 0
- Interest left after tax: Rs 46,288
- Effective return: 7% a year
After 5% inflation, your real return is about 2%.
The calculation shows that for high-income individuals, tax can erase much of the gains made in FDs. If the goal is not simply wealth preservation, but its growth, such individuals can explore other avenues of investments where returns may be higher. But ultimately, this decision should be made after considering factors such as risk appetite, personal goals and near term financial expectations.
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