Interest on fixed deposits is very much taxable. The interest earned from fixed deposits is added to the total income to compute tax liability. If you are in the highest tax bracket, then your post tax returns reduces significantly. Let's assume that a bank gives an interest rate of 6 per cent. If you are in the 30 per cent tax bracket, your returns would reduce to just 4 per cent. Similarly, your returns would reduce even if you are in the other tax brackets. Here are a few investments where the interest income is tax free.
Public Provident Fund (PPF)
The interest earned on the Public Provident Fund is exempted from tax, The PPF also provides you with an interest rate of 7.1 per cent, which is a good 2 per cent more than what banks are currently giving.
Apart from this, the investment also offers you tax benefit under Sec80c of the Income Tax Act. So, all of this makes the PPF a very interesting bet. The one disadvantage is that the PPF is a long term investment, which is for a period of 15 years. Partial withdrawal is only available after a period of 7 years. In short, go for the PPF only if you are a long term investor. The maximum amount that one can invest in the PPF is Rs 1,50,000.
Listed tax free bonds
There were many tax free bonds that were issued by government owned companies like HUDCO, Rural Electrification Corporation, Power Finance Corporation, Indian Railways Finance Corporation etc. These tax free bonds are traded on the stock exchanges and can be bought in the same way an individuals buys shares.
The interest earned on these bonds are tax free in the hands of investors. The interest rates are paid annually and interest mostly ranges from 7 to 8 per cent. Since these bonds are listed, the higher price you buy them lower would be your returns and so on. The lower you buy these tax free bonds higher would be the returns. Since these bonds are Government owned companies they are safe.
Voluntary Provident Fund (VPF)
The Voluntary Provident Fund is an extension of the Employees Provident Fund (EPF). Let's explain. If you are employed than there is a maximum contribution of 12 per cent of basic and DA that you can make towards your EPF.
However, if you want to make more contribution, you have to do it through the VPF. The interest earned on the Voluntary Provident Fund is completed exempted from tax, provided you have made a contribution for 5 years.
The VPF is a good product for individuals as they help them to build a retirement corpus and also the fact that the interest earned after a period of 5 years is tax free. You can ask your employer for the details.
About the author:
Sunil Fernandes has spent 26 years covering business and finance in India and abroad. Sunil has worked with frontline daily newspapers including Hindustan Times, Deccan Herald and Gulf Times. He has also worked with investment magazines like Dalal Street Investment Journal and Oman Economic Review. His forte remains stocks, mutual funds, debt, commodities and tax planning. He is currently the Managing Editor for Goodreturns.in