Bank Fixed Deposits vs Debt Mutual Funds (Taxation)

20160130_FD vs Debt MF Featured Image


For most of us, our search for debt investments begins and ends at bank fixed deposits. When we have idle money in our bank, we invest the excess amount in fixed deposits. Bank fixed deposits are easy to understand. You simply need to walk into the nearest bank branch to invest. Moreover, with net banking becoming more and more popular, opening a fixed deposit is merely a click away for a number of us.

The FD returns are fixed and guaranteed. You don’t really need to worry about whether the banks can default. You believe that the Reserve Bank of India, the banking regulator, will take pro-active steps or in the worst case, the Government will come to your rescue.

Hence, it is no surprise that a number of investors don’t look beyond fixed deposits for their debt investments.

For some of us, debt mutual funds present a credible alternative to bank fixed deposits. Some argue, and correctly so, that the debt mutual funds are more tax-efficient than fixed deposits, especially for those in the higher income tax brackets. However, the returns from debt mutual funds are not fixed. Debt mutual funds face credit risk and interest rate risk and thus your money might be at risk.

Read: Don’t ignore the Risk in Debt Mutual Funds

In this post, I will compare the tax treatment of fixed deposits and debt mutual funds with the help of illustrations. I will compare fixed deposits and debt MF schemes on a few other parameters too.

Please understand I am referring to only bank fixed deposits. I advise readers to stay away from corporate fixed deposits and fixed deposits from co-operative banks.

Read: How to select a debt mutual fund for your portfolio?

Tax Treatment of Fixed Deposits and Debt Mutual Funds

This is an area where debt mutual funds score over fixed deposits.

The interest on fixed deposits is taxed at your marginal income tax rate. For example, if you make a fixed deposit of Rs 1 lac at 8% for 5 years, you will earn Rs 8,000 as annual interest.

You will have to pay tax on this interest income at your marginal income tax rate. If you fall in the highest income tax bracket, you will have to pay an income tax of Rs 2,400 on this income (30% of Rs 8,000). I have ignored surcharge and cess.

On the other hand, in case of debt mutual funds, the tax liability arises only at the time of sale of mutual fund units. So, if you purchase debt MF units today, you won’t have to pay any tax till such time you sell those units. It does not matter how long you hold those units.

If holding period for debt mutual fund units (at the time of sale)  is less than or equal to 3 years, the resulting capital gains shall be treated as short term capital gains and taxed at the marginal income tax rate (income tax slab). The same treatment a debt mutual fund would get.

However, if the holding period is greater than 3 years, the resulting capital gains shall be treated as long term capital gains and taxed at 20% after accounting for indexation. There is a difference in how NRIs get taxed on their debt mutual fund investments. For more on NRI mutual fund taxation, please refer to this post.

Tax Deduction at Source (TDS) for Bank Fixed Deposits

A bank is required to deduct TDS (Tax deducted at source) if the interest paid during the financial year exceeds Rs 10,000 across all its branches. TDS is the tax deducted upfront by the bank (from the interest) and deposited with the Government.

So, if your annual interest from fixed deposits (from a particular bank) is Rs 8,000, there is no TDS applicable. However, if the annual interest is Rs 13,000, the bank will deduct TDS at 10% i.e. Rs 1,300. I have not considered cess and surcharge.

If you have furnished PAN with the bank, TDS will be deducted at 10%. Otherwise, the bank will deduct TDS at 20%. Please understand TDS has no relation to your marginal income tax rate (income tax slab).

Read: How to save TDS on Bank Fixed Deposits?

Do note your income tax liability is not over if the bank has deducted TDS from your interest income. If TDS has been deducted at 10% and you fall in a higher income tax bracket, you need to pay excess tax as advance tax or while filing your income tax return. Similarly, if excess TDS has been deducted, you can claim a refund while filing IT return.

There is an interesting aspect about TDS. The banks pay interest on the balance net of TDS. Therefore, TDS reduces the effect of compounding, at least to some extent.

Let’s suppose you make an FD for Rs 10 lacs at 10% p.a. (compounded annually) for 5 years.  The rate of TDS is 10%. The Impact of education cess has been considered in these examples.

If you were living in a tax-free world, you would receive Rs 16.1 lacs at the 5 years.  You are not that lucky.

The lowest tax bracket has now been reduced from 10% to 5%. The tables below show calculations with 10% as the lowest rate.

Bank Fixed Deposit vs Debt Mutual Funds FD TDS Part 1

However, you are fortunate enough to fall in the highest tax bracket. You pay tax on the interest income every year. You would expect the following (in absence of any tax deduction at source).

Now, let’s see how TDS impacts the calculations.

20160130 Bank Fixed Deposit vs Debt Mutual Funds FD TDS Part 2

You will get only Rs 14.13 lacs (instead of Rs 14.21 lacs). This is because the presence of TDS has reduced the power of compounding. In this case, TDS has shaved off Rs. 8,566 off your returns.

TDS on sale of Debt Mutual Funds

There is no concept of TDS in case of debt mutual funds for resident Indians.  The income tax liability arises only at the time of sale of such units.

In case of NRIs, TDS is deducted at 30% (34.608% after surcharge and cess) if the holding period is less than or equal to 3 three years. In case the holding period is greater than 3 years, TDS is deducted at 20% (23.072% after surcharge and cess) for unlisted funds and at 10% for listed funds (FMPs, close-ended funds).  This is before surcharge and cess. NRIs are charged TDS at the maximum possible income tax rate. You can claim the excess tax deducted at the time of filing tax returns.

Illustration of Tax Benefits of Debt Mutual Funds

Let’s see the impact of taxation on returns from FD and debt mutual funds. I will consider investors from all 3 tax brackets.

Let’s assume debt fund also returns 10% p.a. over 2 years and 5 years. Do note the return of 10% is neither guaranteed nor fixed. The returns are market-linked.

20160130_Bank FD vs Debt Mutual Fund Return Comparison Part 1

You can see the difference is small. The difference is only to TDS on Bank fixed deposit. If the amount were less such that TDS was not applicable, then there would have been no difference between the net realization from fixed deposits and debt mutual funds.

But the real difference comes up when you are investing for more than 3 years. In that case, indexation benefits come into picture.

20160130 Bank FD vs Debt Mutual Funds Return Comparison Part 2

You can see the difference in net realization is huge in this case.

Points to Note

  1. Historical data for cost of inflation index has been used for the illustration. The levels of inflation may be lower in the future. In that case, the tax advantage for debt funds will automatically shrink. This has been the case in recent times (FY2019). The increase in cost inflation index has been quite low.
  2. The return for FD and debt fund has been assumed to be same. The return on FD is known at the time of investment. Returns of debt funds are market linked.
  3. Because of the tax benefits, it is quite possible that debt funds give better post tax returns despite offering lower pre-tax returns. For instance, if the return of debt funds over 5 years was only 9% p.a. while it was 10% per annum for fixed deposits, you will end up with Rs 14.13 lacs in case of fixed deposit whereas you will have Rs 15.34 lacs in case of debt funds.

Should you invest in Bank Fixed Deposits or Debt Mutual Funds?

Fixed Deposits cannot offer any capital gains. Debt funds (especially) offer you the prospect of significant capital gains. However, in bad times, you can face capital losses too.

If you are investing for the short term (less than 3 years), it hardly makes any difference at least from the tax standpoint.

Bank Fixed Deposits are easy to understand.  Not everyone may be comfortable with debt mutual funds.

If you want to invest in debt instruments for up to 3 years, go for bank fixed deposits. Do consider certain practical issues such as penalty on premature withdrawal.

You open an FD for 2 years. However, you happen to need the money after just 1 year.  If you break your FD prematurely, banks can charge a small penalty and also offer interest rate applicable for 1-year deposit (and not 2-year deposit).

Debt funds do not have such issues. You can take money out at any time. However, there might be exit load in some funds. If you are considering debt funds, do consider this aspect in mind.

If you want to invest for longer term (greater than 3 years), opt for debt mutual funds. Debt mutual funds are more tax-efficient than fixed deposits if the investment horizon is more than 3 years.  Indexation benefits will come into play and boost your post-tax returns.

However, do remember even though debt mutual funds can offer you better post-tax returns, there is no guarantee of returns and there is risk involved. The choice of correct debt mutual fund is extremely important. You must be aware of the risk.

As mentioned in this post, I prefer debt mutual funds that have low interest rate sensitivity (low duration) and that invest in high credit quality debt securities.

Bank Fixed Deposits Vs Debt Mutual Funds

20160130_Bank Fixed Deposit vs Debt Mutual Fund Comparison

Additional Read

PFP Primer: All you need to know about Debt Mutual Funds

How to select a liquid fund?

Corporate Fixed Deposits: Should you invest?

All you need to know about Long Term Capital Gains Tax

All you need to know about Short Term Capital Gains Tax

61 thoughts on “Bank Fixed Deposits vs Debt Mutual Funds (Taxation)”

  1. So Deepesh if i hav some lacs to save for some goals in near future (say marriage..exact time frame not known..but hopefully much less than 3years) do u suggest to keep that in bank FD or debt MF ?
    Bank FD rates r all time low now…Highest FD interest i’m getting is in Bandhan Bank @8.5% for any period between 1-3years..other banks r in the range of 7.75-7.9%…

    Debt MF or Bank FD ??

    ( Till now I have some SIP in equity MF…but nothing in debt MF)

    Awaiting for ur valuable suggestion.

    1. Does not matter much. If you think it will happen within 3 years, go with the instrument you are comfortable with.
      In most cases, people are more comfortable with fixed deposits.
      I get your point. Since the exact time is not known, you cannot be sure about the term of the deposit.
      In that case, go for short term deposits, say 6 months to 1 year and keep renewing.
      If you feel it can stretch beyond 3 years, go with debt MF.

      1. Thanx…i wil go with Bank FD as i may need money within 1-2years at the most…and obviously more comfy with FD…plus Capital Gain advantage comes into play only for over 3year deposits in Debt MF.

  2. Hi Deepesh,

    I am 31 and have a monthly take home of 90k. I would like to invest around 25-30k monthly in mutual funds. 1 of them would be ELSS. Rest may be from different categories. Please provide suggestions.Thanks.

    1. Hi Kshitiz,
      This is too little information for me to give any MF recommendations. I need more information about your financial risk profile. Decide the financial goals first and then select the investment products. If you seek professional help, do visit “Our Offerings” section on the website.

  3. Sir, do we have option to start SIP for different kinds of mutual funds by ….say for example Tata….. Or it is just pay the SIP & company decides where it will invest?

    1. Deepesh Raghaw

      SIP is merely a way to invest in mutual funds, where a fixed amount gets debited from your bank account and used to purchase mutual fund units.
      You can choose the mutual fund (where you want to start SIP). Mutual fund managers decides securities to invest in.
      Suggest you seek professional help before investing.

  4. Sir in SIP ….. Can we withdraw money anytime ? …..without any hassle or we have to complete a particular period .

    1. Deepesh Raghaw

      Unless it is tax-saving mutual fund (ELSS), you can withdraw anytime. With ELSS, you have a lock-in of 3 years.

  5. Sir , in SIP ……is MY Capital protected ? ….by means of insurance (just like a limit of 1 lac in co-op sector banks) by the mutual fund house or is completely market oriented ?

    1. Deepesh Raghaw

      No. The returns are completely market-linked. The returns are not guaranteed and you can even suffer capital loss.
      Suggest you seek professional help.

  6. Are GOI: RBI 8 % (taxable) Bonds 2003 …interest Taxed at source (TDS )? ….. Even if interest is well Below ₹10000!…… Plz clarify

    1. Jagdish, my understanding of Section 193 suggests that TDS (at 10%) will be deducted for interest in excess of Rs 10,000.
      No TDS if interest is below Rs 10,000.
      Do note interest from such bonds is completely taxable at marginal income tax rate.
      If excess TDS has been deducted, you can claim it back while filing return.
      Alternatively, if you fall in higher tax bracket, you need to pay the difference tax.

      1. Thanks sir, …….but the financial services person who gave me the form of HDFC Bank of GOI 8% (taxable) bonds & said bonds will be issued by bank on behalf of govt & …..that TDS is Compulsory !….whatever be the interest earned!

        1. You are welcome, Jagdish.
          I would never trust what bankers say.
          However, I wrote upfront I am not sure. Going by my reading of Section 193, the interest in excess of Rs 10,000 is subject to TDS.
          Personally, I wouldn’t worry much about TDS. Entire interest is anyways taxable.

  7. Thanks for a very good explanation.

    Just a small feedback, please correct this line ‘while it was 10% per annum for fixed deposits, you will end up with Rs 14.13 lacs in case of fixed deposit whereas you will have Rs 15.34 lacs in case of fixed deposits.’

  8. Hi Deepesh,

    I am a NRI based in UAE. Since there is not tax on FD or in the residing country, I guess it is better for me to invest in FD instead of debt funds. Am I right?

    1. Deepesh Raghaw

      Hi Biju,
      Think you are right. I assume your are talking about NRE fixed deposits. Interest on NRO deposits it taxed.
      Yes, unless you are planning to take a bet on interest rate movement, NRE FDs will do quite well.
      With debt funds, there will be additional hassle of TDS at the time of redemption.

  9. Sir, You have mentioned that there will be marginal income tax rate for interest below 10000 or in debt funds below 3 year.My question is who will calculate and deduct that income tax?And what is the rate?Should we file returns as in case if tds deducted?

    1. Deepesh Raghaw

      Hi Pristy,
      Marginal income tax rate is your income tax slab.
      So, essentially, your income from FD or short term capital gains from debt funds will be added to your income for the year and taxed accordingly.
      In FD, there will be TDS at 10%. If you fall in the higher income tax bracket, you will have to pay additional tax. It is your responsibility to find out.
      In case of debt funds, there is no concept of TDS for resident Indians. You must calculate tax liability yourself and pay tax. Again it is your responsibility.
      TDS does not complete your tax liability. You may have to pay additional tax.
      You have to calculate

      1. Sir, Suppose if am a salaried person and invest that salary to mutual funds.And I am paying tax for my salary.After 3 years say for debt fund or any taxable funds,if i close the lumpsum deposit including say profit.Then for which amount the tax is calculated?

  10. Hi

    Can I invest in mutual fund through credit card. I just wanted know if this is possible & how? I know bank will charge 36-40% interest on credit car but because of some commitments I have to do it.


    1. Deepesh Raghaw

      Dear Vandit,

      Please don’t even think about it. Makes absolutely no sense. And I can see you already know that.
      Fortunately, mutual fund investments can not be made through credit cards.

      1. Hello Deepesh,

        But investing through credit card will not be illegal, Right? If I do it by some other way.

        1. Hi Vandit,
          Don’t know the legality but you can’t do it.
          The debit for investment has to be from savings bank account.


    Hi Deepesh,

    What’s the outlook on yields on Ultra Short term debt mutual funds in the next 3 year time frame? Are the returns likely to go up / fall?

    1. Hi Subroto,
      I don’t have any outlook. That’s why I choose ultra short term debt funds. So that I don’t have to worry much.

  12. I have 10lac in my saving account. I want to put it in FD . Please suggest should I go for FD or debt fund. I checked fds are not giving return more than 7.5%.
    Duration is more than 1year but less than 3years.

    1. If the investment horizon is less than 3 years, then it does not matter.
      You can go with either.
      However, in case you are not sure about the investment horizon, then go for debt mutual funds.
      There are many variants of mutual funds too. Pick a ultra-short term debt fund.

  13. I have 10lac in my saving account. I want to put it in FD . Please suggest should I go for FD or debt fund. I checked fds are not giving return more than 7.5%.
    Duration is more than 5 years

  14. Being interest rate is slashed drastically, will it be good idea to buy Gilt – Long Term Fund now, and hold it till Modi Govt stays ( His govt focuses on low interest rate, since they started governing )

    1. Sunil,
      You gain more if the rates go down after you purchase long duration bonds. And rates do not have to go down necessarily. Most times, an expectation of a rate cut is enough for the price to move. If you check near-term performance of a gilt funds (long term), those have already moved up significantly.
      You need to see if there is further scope for such funds to go up.
      Easier said than done. Every government or the Central Bank would want to have low interest rate and low inflation. Unfortunately, it is not so easy.

  15. Thanks for your reply.
    While observing nav movement for a month its around 5% change, in Long Term – Gilt. So if we find/expect interest rate in reversal i.e starts moving up, we can wind up immediately right ?

    However, not sure this weekend, long term – gilt shows in -ve …profit booking ?

    1. Yes, if you can do that. Don’t ignore tax impact.
      Please understand interest rate is just one of the factors.
      Pure demand and supply can also affect prices.

  16. Hi Deepesh,

    My mother wants to invest in some quality debt funds. In equity mutual funds, there are two options: regular and direct. For debt also, do we have these options? And if she invest with the help of a distributor/broker, then will AMC be providing some charges/brokerage to him? She doesn’t have net banking, then is there a way for her to invest online?


    1. Hi Ankit,
      Yes, you have direct plans for debt funds too but the impact is not very high.
      Suggest you go through the following post.

      Yes, she can invest online without having net banking. My father does not have net banking. Still, he can transact online.
      So, you need to provide one-time mandate to the AMC and you are set. When you initiate transactions, your bank account will be automatically debited.
      You can also register with a portal such as MF Utility where you can fill up PayEezz form (one-time mandate) and then your bank account will be linked.

      1. Thanks Deepesh for replying. Just few more queries. With MFUtility, internet banking is not needed. Right?

        Basically the thing is, it is her money but since she is not very good with computers, she don’t want to activate internet banking. So, I will create a MF Utility account for her if it is possible without internet banking.

        Also, which debt funds you would suggest since she is getting a FD being matured this month. She don’t know when she will need this money so I want to get it invested in some debt instrument.

        Thanks a lot,

        1. Ankit,
          If she is not comfortable using computers, you need to revisit the approach.
          Even with MFU, she will have to use a computer and internet (even though she can do without net banking).
          Either you help her out (handle her portfolio) or she can go through a MF distributor who can help her. She can consult a SEBI RIA too.
          Btw, direct plans are not meant for everyone.
          Personally, I prefer shorter duration funds.
          Btw, I gave MFU as an example. There are other platforms too that you can try out.

  17. Hi.i am a family of three.have corpus of 30 lacs.wanted to invest in something which would keep the capital safe and bring monthly income for survival.not in job and don’t know when I would get one.

    1. Dear Mukunda,
      You can stick with plain vanilla fixed deposits.
      If you are comfortable with debt mutual funds, you can stick to high credit quality ultra short term debt funds too.

  18. Debt MF’s have been giving returns in range of 10 to 15 % in the past few years. With interest rates going down, debt mf valuations increasing, do you think it is right time to buy into debt MF now or are they at the peak? Will they be able to sustain this type of returns in the near future?

    1. Dear Ravi,
      Not all debt MFs have given these kind of returns.
      If the interest rates move down as they have in the last couple of years, you can expect a similar performance.
      Do you expect similar rate cuts in the next couple of years?

  19. TDS on sale of Debt Mutual Funds

    There is no concept of TDS in case of debt mutual funds for resident Indians. Income tax liability arises only at the time of sale of such units.

    Please refer your following comment “In case of NRIs, TDS is deducted at 30% (34.608% after surcharge and cess) if the holding period is less than or equal to 3 three years. In case the holding period is greater than 3 years, TDS is deducted at 20% (23.072% after surcharge and cess). This is before surcharge and cess. NRIs are charged TDS at the maximum possible income tax rate. You can claim the excess tax deducted at the time of filing tax returns.”

    I would like to know whether tax is same for Debt Funds purchased from fund of remittance by N.R.External (NRE) or exempt like interest on Bank F.D any indexation benefit available?

    1. Dear Pradip,
      Your mode of payment does not change the tax treatment. Does not matter if you purchase from NRE or NRO account.
      Indexation benefit is available to NRIs too.

  20. Sir, Thanks for sharing detailed information. I have corpus of 15 Lakhs, Can you please advice some good debt funds or any other funds for where to invest in? I have horizon of 5 years.

  21. Deepak. Your articles are good to read and learn. More importantly i can find honesty in them. Great work friend. Keep it up.

    1. Thanks Venkat.
      Appreciate your kind words and feedback.
      Will appreciate if you could share the post with your friends and family too.

  22. Nice inputs man.. Thanks for the service. it helps lot of people. Keep rocking

    Thanks and Regards,

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