Should senior citizens invest in recurring deposits merely for high-interest rates?

Many banks have hiked interest rates on recurring deposits (RDs) to seven per cent, thus, encouraging many investors, especially senior citizens, to park their funds in them. Considering how many people want to lie low and put their money in risk-free instruments, recurring deposits can be a great way of earning interest on the investments made.

Benefiting from RDs

The best part of putting money in recurring deposits is that one can invest monthly instead of putting all money in a lump sum. This makes way for gradual investments in small instalments and enough scope to create wealth, albeit slowly. You can deposit for a minimum and a maximum period of six months and 10 years, respectively. 

Investors looking to park their money with a short-term financial goal in mind can consider putting their money in them. The current 7 per cent interest rate on offer for five years, though is not enough to beat the present inflation rate, offers relief to investors not yearning for huge returns.

RD returns vs Debt funds returns

While the increased interest rates may be enticing, is it worth your investment? While you may put money in RDs thinking that those returns would be enough to create wealth, think again. An alternative option could be to put money in debt funds for better returns while gaining from tax breaks too.

Numbers speak more than words. The following table highlights returns from both RDs and debt funds over a span of five years, thus, allowing you to make a better choice.

Burden of taxation

One may argue how the returns from RDs explain their growing inclusion in an investment portfolio. However, what many do not understand is that these returns are futile considering how they would be eaten up in taxes.

The interest earned on RD is subject to taxes. Tax is deducted at source (TDS) at 10 per cent on interest income exceeding ₹40,000. However, in the case of senior citizens, the limit is raised to ₹50,000 which means that in this case 10 per cent tax would be charged on ₹12, 046 ( ₹62,046- ₹50,000).

Debt funds are however taxed differently. A lot depends on the holding period of debt funds. Since investments in these debt funds extend beyond three years, these would be classified as long-term debt fund investments. Long-term capital gains on debt funds are taxed at 20 per cent with indexation.

Dev Ashish, Founder, Stable Investor says, “Indexation is a way to adjust capital gains as per the prevailing inflation index. So via indexation, the purchase price of an investment is adjusted for inflation (usually upwards). By increasing the purchase cost, the capital gain for tax purposes is reduced. And as a result, the actual tax you pay also reduces significantly.”

“The Long-Term Capital Gains on debt mutual funds are taxed at 20 per cent after indexation. That is, you can adjust the cost of acquisition of debt fund units for indexation first. This requires the use of the Cost of Inflation Index (CII).

Using the CII numbers,

CII number for 2016-17 (year of investment) = 264

CII number for 2020-21 (year of sale) = 301

Now the indexed cost of acquisition is calculated using the formula - Indexed Cost = Actual Cost * (CII of Sale Year / CII of Purchase Year),” he added.

The indexation benefit gives debt funds an edge over other fixed-income investments such as bank deposits in terms of the post-tax returns. More so for those in higher tax brackets. Remember that the interest income earned on a bank fixed deposit is added to the total income and taxed at the income tax slab applicable to the depositor. There is no option to reduce tax outgo for bank FDs using indexation.

Debt funds carry an inherent risk though the same is mitigated in the long run. This means that the risk factor gets waived off with time. The returns are not fixed, though the post-taxation benefit lends them an edge over bank-sponsored fixed income deposits.

Senior citizens willing to set aside a part of their pension income in five-year investments can consider putting money in them. However, given the current scenario when interest rates are slated to increase in response to RBI repo rate hikes, one must compare and contrast the pros and cons before investing.