FD vs SWP: Follow these steps to reduce your tax outgo by 97%

Where will you invest your money for earning some regular income? The most expected answer is fixed deposit, as it is simple to understand plus it gives you fixed returns. But before investing you also need to take into account the tax element. You cannot ignore it as interest income in FDs is taxed as per your tax slab which can be as high as 20-30 per cent.   

For example, if you invest Rs 10 lakh then you can earn Rs 12,500 every quarter, or Rs 50,000 every year, at an assumed interest rate of 5 per cent. Now on this Rs 50,000 interest income earned every year you also need to pay tax. Assuming you fall into the tax slab rate of 30 per cent, it will work out to Rs 15,000. Now there is a way to reduce this tax liability to just Rs 457. Here is how:

The answer lies in SWP or Systematic Withdrawal Plan, which is opposite of Systematic Investment Plan or SIP where you give a mandate to your mutual fund to withdraw a fixed amount at regular intervals. It might sound similar to FD where you invest and in return regular payments are made. But the similarities end here as the taxation method is quite different for the two.

Why? It is because in mutual funds units are redeemed every month to give you regular income. Hence, the redemption amount consists of principal and capital gains and the tax liability will arise only on the capital gains component. But in case of fixed deposit the entire interest income becomes chargeable to tax.  

You can start SWP from both equity or debt funds, but usually debt funds are preferred for regular income after retirement. One important point in case of debt fund is if you redeem units before three years, capital gains is taxable as per the slab rate, while long-term capital gains are taxed at 20 per cent with indexation.  

So instead of FD, if you invest the same amount of Rs 10 lakh in a debt mutual fund at an NAV of Rs 40, you will receive 25,000 units. Assuming the debt fund will give 5 per cent returns per annum, the NAV will grow to Rs 40.50 after a quarter. Now if you opt for quarterly withdrawal of Rs 12,500, in the first quarter you will be redeeming 308.64 units. Since only capital gains component will get taxed, which is Rs 0.50 (40.50-40) per unit, the value of your capital gains will be Rs 154. The tax on the same at 30 per cent will amount to Rs 46. If you repeat the same exercise for the remaining three quarters the yearly capital gains will amount to Rs 1524 and the tax liability will come in at Rs 457, which 97 per cent lower than FDs.

But before availing SWP do understand that interest rate in FDs is fixed while return in debt funds is fluctuating because of interest and credit risks. Moreover, there is an exemption of Rs 10,000 under Section 80TTA on total interest earned including your bank accounts, RDs and FDs. This limit is higher in case of senior citizens which is Rs 50,000 under section 80TTB. There is no such exemption on return from mutual funds. So, take the exemption part into consideration while analyzing the tax benefits.  

Last but not the least, the advice is to diversify between FD and debt funds and stick to funds investing in AAA-rated instruments so that you have the double advantage of low tax and stable returns.