10 Common Myths Surrounding Fixed Deposits and Earned Interest

Fixed Deposits, also called as Term Deposits, are one of the most traditional investing options. While we may be hearing a lot of noise around Mutual Fund SIPs, Liquid, Balanced and Debt Funds, Stock Picking, Tax Free Bonds, PPF, EPF etc, the fact of the matter is that nothing can beat the assurance and simplicity of a Fixed Deposit. Though tax inefficient and not the best returns provider, fixed deposits do deserve their own pie in your portfolio. Tell me whether there is any other investment option you know which is as simple, assured, liquid, monitoring free and risk free – all rolled in one – as a Fixed Deposit? There is actually none. It does come at a price of tax inefficiency and slightly lower returns, but in quite many cases – returns may not be the only criteria to decide on your investments.

So, if you have started to feel happy that all that chunk of Fixed Deposits lying almost unattended in your bank accounts is now justified, let me throw a word of caution here. Your Fixed Deposit is earning interest. Bank may be deducting some tax as well (TDS). But you may be liable for more tax. And if you have not been paying that, you might be in for deep trouble. Yes, at the time of filing your Income Tax Returns, you are liable to calculate the additional tax that you need to pay from your Fixed Deposit interest – and then pay it as well. This may be completely over and above the TDS that the banks may have deducted. If you have been ignoring that, then I am sure you also understand that ignorance of law is never an excuse. Inefficiently managed interest accrued from your Bank Fixed Deposits can actually land in you in deep trouble with the taxman.

Let us remove some of the common myths surrounding the Fixed Deposits and the interest accrued out of them:

Myth 1

Fixed Deposit interest is hidden from the taxman

Fact 1

All Banks report the interest accrued against your PAN Number to the IT Department. So, gone are those days when banks and their branches were disconnected. Today, in this interconnected world of PAN and Adhaar, there is no way you can escape from the prying eyes of the taxman.

Myth 2

Bank has already deducted 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 liable 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 from fixed deposits – after adjusting for 10% or 20% TDS that may already have been deducted by the bank. If you are in the 20% tax bracket, and the bank has deducted only 10% TDS, then you are liable to pay another 10% tax on the interest that you have earned.

Myth 3

You have submitted Form 15G/H – so there is no tax liability

Fact 3

Form 15G/H has a very specific purpose wherein 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 requesting the bank not to deduct TDS. But if that does not turn out to be true by the end of the financial year, you got to pay tax as per the tax slab you fall in.

Myth 4

Your interest is less than Rs 10,000 in a financial year and thus there is no tax liability

Fact 4

Even INR 1 interest earned from Fixed Deposits is liable to be taxed, unless of course you fall in 0% tax slab. This exemption of Rs. 10,000 is not applicable on Fixed Deposit interest. This exemption is only available for interest earned out of the money idling in your savings account. So, you are liable to be taxed even if your interest income is less than INR 10,000. The only benefit you have is that the bank will not deduct any TDS till the interest crossed INR 10,000. Even if that is the case, you will need to pay the applicable tax at the time of filing ITR.

Myth 5

I have a recurring deposit. Interest is not taxable here

Fact 5

100% incorrect. Whether it is FD or RD, every single rupee of interest earned is taxable as per your current tax slab

Myth 6

I have invested in a 5 year Tax Free FD. It will not be taxed now

Fact 6

Quite contrasting to their name, Tax Free FDs are actually NOT tax free. Yes, they don’t help you save tax from your interest income earned out of the fixed deposit. They do help you save tax by showing the principal investment under Section 80C, just like you may save tax by showing EPF or PPF investment under Section 80C. However, every single rupee of interest is taxable as in 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 as in any normal fixed deposit.

Myth 8

Senior Citizen Deposit Scheme is Tax Free

Fact 8

Again, none of this is true, and every single rupee of interest is taxable as in any normal fixed deposit.

Myth 9

I have invested in an FD in my wife’s name. So, I am saved of any taxes.

Fact 9

Money gifted to a spouse does not attract tax. But if that money is invested, the income it generates is clubbed with the income of the giver and taxed accordingly. If a husband has invested in fixed deposits in the name of his wife, the interest will be taxed as his income. So, better avoid wasting your time and effort.

Myth 10

I have invested in my child’s name. So, I am saved of any taxes.

Fact 10

Money gifted to a child does not attract tax. But if that money is invested I the name of aa minor child, the income it generates is clubbed with the income of the giver 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 your time and effort. In case of children though, there is a small exemption of Rs 1,500 per year per child for a maximum of two children.

Calculate the Tax payable on FD interest

1. Calculate your total interest income from all the Fixed deposits in a financial year. Say, it is INR 50,000

2. Find your tax slab (based on your total income – which includes all sources of income, including FDs). Say, it is 20%

3. Based on 1 and 2 above, calculate the tax payable on FD interest. It will be 20% of 50,000 = INR 10,000

4. Check Form 26AS to see the TDS already deducted. Assuming it was deducted at the standard rate of 10%, it will be INR 5,000

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 Tax for interest income?

Report the total interest as “Income from other Sources”

In the ITR form, it will be added to your total income and will be taxed according to the tax slab you will fall into.

Avoid trying to be smart with the IT Department

In today’s interconnected banking system, avoid the following, play safe and live a peaceful life:

1. Do not try to submit Form 15G/H just to avoid TDS. Giving a false declaration can be considered a very serious offence – which could even lead to jail up to 2 years. This information makes its way to the Form 26AS of the individual. One can only imagine what will happen to an investor whose Form 26AS indicates submission of Form 15G or 15H at multiple banks and an income that exceeds the basic exemption limit. In any case, even if you are able to avoid TDS by the bank, you are liable to calculate and pay the total tax while filing ITR. Playing such games is just not worth the effort.

2. Do not waste your time and energy splitting your bank FDs across multiple banks or branches. Every account is connected through your PAN number.

3. Avoid trying to save tax by investing in the name of your spouse or minor children. There is a clubbed income provision which leads to all the interest earned by your spouse or child to be clubbed with your income and taxed accordingly. In some cases, it might help investing in the name of your parents, because the clubbing provision does not apply there. However, just ensure that the parents income and tax liability should not go up because of that.

Don’t Make This Retirement Mistake

On the dashboard of my personal financial software, there’s a number.

Financial gurus tell me this number is one of the three most important in my life. One other is my credit score. The third is my age. (After all, I can shape the other two only if I’m still kicking.)

I certainly don’t measure myself against these numbers. Although I admit to paying a lot more attention to the age figure as it creeps up.

But other people use them to assess me, that’s for sure.

In fact, to hear some folks tell it, these little financial indicators are more important than a person’s morality, ethics or good works. (Particularly nasty are dating sites that require your credit score… the romantic in me says yuck to that.)

Age, credit score and… can you guess the other number? Do you know yours?

Above all, can you rely on its accuracy? What if it’s just a mirage?

You wouldn’t go out to sea without knowing precisely how much fuel, water, food and other essentials you had on board. After all, your life depends on it.

But there’s a good chance you’re heading into retirement with a faulty figure for your net worth…

Speculating on Your Future

Ever since I studied economics at university, the distinction between price and value has fascinated me.

Price is the amount of currency someone wants to part with for something at any moment in time.

$1.75 for a grande at Starbucks.

$299 for the latest video game console my daughter wants for Christmas.

Value is our subjective assessment of how useful something is. My daughter’s video game may cost $299, but I promise you, at that price there are many things I could use a lot more.

In markets, price is supposed to be an indicator of value. But prices have a way of becoming detached from value.

For example, a while back every kid wanted a silly little gadget that spins on your finger. For a few weeks they were selling for ridiculous prices because demand was so high. Once the kids figured out it was actually a boring little gimmick, the price dropped.

But trouble really starts when you introduce time into the price/value relationship. That’s where net worth comes in.

For example, right now I think my home will fetch a certain price. That price contributes a sizable chunk to my net worth. My net worth, in turn, is the foundation of my retirement plans.

I’m certain I could sell my home right now to one of the young families flooding into my neighborhood because of the good schools. They have the income to afford my price.

But I don’t plan to sell my house for another couple of decades at best. What if the young families of the future can’t afford my price?

What happens to my net worth then?

Beggar Thy Children

When we retire, we usually cash in the assets that make up our net worth, including our homes. For example, a couple I know recently sold their home and used the proceeds to acquire an assisted living apartment that will take care of them for as long as they live.

But if today’s younger generation can’t afford to buy our homes at the prices we use to measure our net worth, we may be stuck.

And it certainly looks as if the kids won’t be alright in 2037.

According to the Credit Suisse Research Institute’s global wealth report, if the world’s wealth were divided equally, each household would be worth $56,540.

But the top 1% own more than half of all wealth. The median household wealth is just $3,582. If you’re worth more than that, you’re in the richest 50% of the world’s population.

We can debate the reasons for this lopsided distribution of wealth. But there’s no debating the fact that people who reached adulthood since 2000 are on the losing end of it.

It’s particularly bad in the U.S.

On average, Americans between 30 and 39 have half as much wealth in 2017 as that age group had in 2007.

That means they will be significantly less well-off 10 to 20 years from now… unable to afford the sort of homes we take for granted today.

In other words, thanks to increasing inequality, you may be heading into retirement with faulty numbers.

Plan Your Future Around Value, Not Price

I constantly ask myself: What’s the Big Idea in my writing? What ties it all together?

As I wrote this article, it struck me that my Big Idea is the absolute importance of planning your future based on value, not price.

You know, for example, that you can’t rely on current stock prices to remain the same throughout your retirement. Converting stock holdings to other assets that tend to hold their value before stock prices fall is a key strategy.

Given what wealth inequality is doing to our younger generations, if you’re heading for retirement in the next couple of decades, you may want to consider the same strategy… when it comes to your home.

Market Numbers Through 2017 – Not Quite As Impressive As You Think

No one would deny that 2017 was a banner year for the markets… at yearend, all the equity indices were close to their all time highs. Even the WSMSI (Working Capital Model Select Income Index) had a capital growth number approaching 12%.

But, lets step around Wall Street’s promotional pennants, and look at the numbers over the longterm, say this century so far…

You’ll recall that the period from 1999 through 2009 was dubbed “The Dismal Decade” by a Wall Street that just couldn’t cope with the idea that the “shock market” (collectively) could actually go backwards over such a long period of time.

Has the “bull market” that evolved from the dismal decade really produced the type of gains you’ve been hearing about?

· From 1999 through 2009, the NASDAQ (home of “FANG” type companies since forever) shrunk by a whopping 34%. From 1999 through 2017, it was the worst performing of all the indices, rising just 71%, or an average of less than 3% compounded, per year. So even the spectacular 160% market value gain since 2009 hasn’t produced spectacular longterm performance.

· From 1999 through 2009, the S & P 500 (although less speculative than the NASDAQ overall) lost a scary 39% of its value. Recovering more quickly than the NASDAQ, the S & P has gained approximately 94% in market value over the past 18 years, or an average of less than 4% compounded, annually. So not so much to celebrate in the S & P either… for the longterm investor.

· From 1999 through 2017, the higher quality content DJIA suffered less than the other indices through the dismal decade, losing less than 1% per year, on average. But its 18 year, overall performance, of 115% market value growth was an average of less than 5% per year. Reflective of higher quality content, yes, but really not so impressive overall.

So what about an income purpose investing approach during the same two time periods?

· From 1999 through 2017, a $100,000 portfolio of income Closed End Funds (CEFs) paying roughly 7% per year, compounded annually, would have grown the invested capital to roughly $340,000 by the end of 2017… a 240% gain in Working Capital, and nearly three times the average longterm gain of the three equity averages!

· During the dismal decade itself, a $100,000 portfolio of income CEFs paying 7%, and compounded annually, would have grown the investment capital by roughly 111% (10% annually).

· Note that the average annual gain of roughly 13% is based on annual rather than monthly reinvestment of earnings… so it would actually be even higher. Hmmm, kinda makes you wonder, doesn’t it?

Now some what ifs:

· What if you were living on the income or growth of your portfolio at any time before mid-2010?

· What if you were living on 4% of your portfolio “growth” or “total return” prior to the end of 1999, how much did you have left when the rally began in 2010?

· What if we don’t get enough more years of double digit market growth for the equity markets to catch up with the income illustration above?

· What if the market doesn’t produce “total return” greater than your expenditure needs forever?

· What if your portfolio contained enough income purpose securities to provide for your expenditures, combined with equity securities of a quality superior to those contained in the Dow?

· What if the stock market corrects again this year?