While equity investments may bring better returns, debt instruments are considered safer. Investors should be aware of the taxation rules to better understand the net returns.
Your investment should be a balance of debt and equity instruments. While equity investments bring in higher returns, they are riskier than other assets. Debt instruments, on the other hand, carry some risk, but are considered safer than equity instruments. Diversification of investment portfolio will help the investor reduce overall risk and cushion it against adverse market reactions. However, before investing, all investors should be aware of the taxation rules to better understand the net returns.
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There is a variety of debt investment instruments in the market such as fixed deposits, debt oriented mutual funds, post office savings, Senior Citizen Savings Scheme (SCSS) and National Savings Certificate (NSC). Bank fixed deposits are the most popular debt investment instrument. An investor should take into account the safety and tax implication of a debt product before selecting it.
Here’s a look at the tax implications of some popular debt investment instruments.
Bank fixed deposits
Investors can exploit the complete potential of Section 80C of the Income Tax Act under the old tax regime with fixed deposits and get a deduction of Rs 1.5 lakh from their taxable income. However, interest income from bank FDs is fully taxable. Individuals below the age of 60 years get taxed at the slab rate applicable, while senior citizens can get exemption on interest up to Rs 50,000.
Post office savings
As post office scheme are backed by the government, the risk is almost zero for these investments. Moreover, such investments qualify for tax exemption under Section 80C of the Income Tax Act, 1961. Investors can reap tax benefits of investing in five-year post office time deposit. Like bank deposits, interest income from post office deposits is taxable as per slab rates. For senior citizens, interest up to Rs 50,000 is tax exempt.
Senior Citizen Savings Scheme
The principal amount deposited under Senior Citizen Savings Scheme is eligible for tax deduction of up to Rs 1.5 lakh under Section 80C of the Income Tax Act, 1961. However, interest is taxable as per the applicable tax slab and no tax is deducted at source on interest up to Rs 50,000 for a fiscal year.
National Savings Certificate
A subscriber can get a tax rebate under Section 80C for investment in National Savings Certificate up to Rs 1.5 lakh. Further, if the subscriber adds the interest earned on the certificates to the initial investment, it qualifies for a tax break of up to Rs 1.5 lakh.
Debt oriented mutual funds
Debt funds are a class of mutual funds that invest in fixed income instruments such as corporate and government bonds, corporate debt securities and money market instruments. Dividends earned from debt mutual funds are taxable under the Income Tax Act, 1961. The dividends are added to the overall income of the investor and taxed as per the slab rate applicable.
Short-term capital gains of debt mutual funds are added to the investors overall income like dividends and taxed at the income tax slab rate. Long-term capital gains are applicable to debt fund holdings kept for more than three years. This is taxed at a flat rate of 20 percent, and is irrespective of the income tax slab rate of the investor.