Investment is a vast topic, there are many things to consider before investing anywhere. People still prefer going the traditional way, of investing in fixed deposits and recurring deposits. For them, it is the best and safest option to invest in. What they don’t consider is the tax rate. In fact, if you go to see the returns are much less after considering the tax.
Recurring deposits are like fixed deposits, but you have to invest a certain amount regularly. It’s like regular savings for an individual. For example, a person is investing Rs. 1000/- monthly in a recurring deposit. The minimum period of recurring deposits is 6 months, and a maximum is 10 years. This gives a person the opportunity to save regularly and makes it a habit. An individual can give instructions to the bank, to transfer a certain sum of money every month into the Recurring Deposit account (RD).
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In RDs if the installment is delayed or not paid, then the interest will be reduced as a penalty and this, in turn, will reduce the maturity value. The rate of penalty will be decided initially. You can avail loans and keep your RDs as collateral but only up to 80% or 90%. The rate of return of an RD is same to that of a fixed deposit.
Taxation of Recurring Deposits
Now let us look at the taxation part, Tax deducted at source is applicable in the case of RDs. Tax is deducted from the interest earned on the deposit. TDS at the rate of 10% is deducted by the bank. Income tax is to be paid as per the tax slab of the RD holder, on the RD. Those investors who do not have a taxable income, have to fill and submit a form 15G to avoid TDS on their RDs and for senior citizens is 15H.
Now lets talk about mutual funds, they are a collection funds from investors which are invested in different avenues in the market. Mutual funds are more riskier than RDs. Mutual funds are vast, there are so many schemes under Mutual Funds (MF). You have equity and debt funds, under this there are various schemes. Unlike RDs there’s no penalty if you discontinue your SIPs. For example: If a person has a monthly SIP of Rs. 1000/-, and after few years he stops his SIP, he will get returns on the existing amount in his fund. They will be no penalty for discontinuation of SIP.
We shall now take debt funds. Debt funds are mutual funds which are invested in fixed income securities, like bonds, treasury bills, Govt. securities, etc. They are less riskier as compared to equity funds. They are mostly used to fund short term goals. An added advantage is that there’s liquidity. Its returns are higher as compared to RDs. Debt funds are also invested in short, medium and long term bonds. These funds are meant for those investors who do not want to take a high risk. Debt funds are steady in nature compared to equity.
Equity funds are mutual funds invested in the equity market. These funds involve a lot of risks. There are many schemes under these funds as well. They are mostly used to fund long term goals. These equity funds are meant for those investors who are willing to take the risk and understand the market volatility.
We shall now see how are debt funds and equity funds taxed:
- In case of debt, if the fund is held for less than 36 months, then it is considered as short term gain and is taxed as per your slab rate. More than 36 months is considered as long term and is taxed at 20% with indexation.
- In case of Equity, if the fund is held for less than 12 months, then it is short term capital gain and it is taxed at 15%. More than 12 months, it is considered long term capital gain and is tax free upto a gain of 1,00,000. Any gain over a gain of 1,00,000 will be taxed at 10% without indexation.
Let us now compare the returns of an RD and an equity SIP
As you can see in the above table, the returns from the equity SIP is much more than the RD returns. If you are looking at short term investment, RD is good, but if long term, then Equity SIP is the right investment avenue. For short term, you may also look for Debt Mutual funds depending upon your risk profile.
Having said all this, it all depends on the investor’s risk appetite and what he’s comfortable in. It is always good to explore your options if you are at a younger age. If you are closer to your retirement age, then it’s better to be on the safer side.