Where will you put your money to generate a steady income? Because it is straightforward to comprehend and provides fixed returns, the most anticipated response is a fixed deposit. However, you must also consider the tax aspect prior to investing. You can’t ignore it because interest income from FDs is taxed at a rate that varies depending on your tax bracket and can be as high as 20-30%.
If you invest Rs 10 lakh, for instance, you could earn Rs 12,500 every quarter, or Rs 50,000 annually, assuming a 5% interest rate. You now have to pay tax on the Rs 50,000 in interest income you get each year. It will amount to Rs 15,000 if you qualify for the 30% tax bracket. This tax obligation can now be reduced to just Rs 457. This is how:
The answer is SWP, which stands in contrast to SIP, or Systematic Investment Plan, in which you instruct your mutual fund to withdraw a predetermined sum on a regular basis. It may resemble FD, in which you invest and receive regular payments in return. However, the two have very different approaches to taxation, so the similarities end here.
Why? This is due to the fact that mutual fund units are redeemed monthly to provide you with a regular income. As a result, only the capital gains portion of the redemption amount will be subject to taxation because it is made up of principal and capital gains. However, with a fixed deposit, all interest income is subject to taxation.
You can start a SWP with equity or debt funds, but debt funds are typically preferred for regular retirement income. In the case of a debt fund, one crucial point is that long-term capital gains are taxed at 20% with indexation if you redeem units before three years have passed.
Therefore, if you invest Rs 10 lakh in a debt mutual fund with a NAV of Rs 40, you will receive 25,000 units instead of FD. After a quarter, the NAV will rise to Rs 40.50 assuming annual returns of 5% from the debt fund. Now, if you select a Rs 12,500 quarterly withdrawal, you will redeem 308.64 units in the first quarter.
Your capital gains will have a value of Rs 154 because only the capital gains component will be taxed, which is Rs 0.50 (40.50-40) per unit. The same will be subject to a 30% tax that will amount to Rs 46. If you do the same thing for the remaining three quarters, your annual capital gains will be Rs 1524 and your tax bill will be Rs 457, which is 97% less than your FDs.
However, before applying for SWP, be aware that while the interest rate on FDs is fixed, the return on debt funds varies due to interest and credit risks. In addition, your bank accounts, RDs, and FDs are exempt from Section 80TTA’s interest tax in the amount of Rs 10,000.
Under section 80TTB, this limit is higher for senior citizens, at Rs 50,000. Returns from mutual funds are not exempt from this. Therefore, when evaluating the tax advantages, take into consideration the exemption portion.
Last but not least, the advice suggests that you stick with funds that invest in AAA-rated instruments and diversify between FD and debt funds for the double benefit of low taxes and steady returns.
