How Liquid Funds trump Bank Deposits for high tax payers
Bank accounts are great, but Liquid Funds can be a better option, especially so for high-networth individuals like you.
Liquid Funds are very similar to Bank Deposits in that they can be redeemed in short notice and hold less risk from a volatility and capital perspective. There are two options that are available to you if you are looking at investing in liquid mutual funds.
Going for the growth option: Under this option, you will be charged for the number of days you are holding the fund, and more specifically, this depends on the tax slab you belong to. If you book gains within 3 years, you will be charged as per your income tax rate of 30%. This is similar to bank deposits. The real advantage lies in for you opt for the dividend option.
Going for the dividend option:In this case, the mutual fund company itself is charged with the Dividend Distribution tax at a predetermined rate of 28.325%. Let us take an example here. You, belonging to the 30% tax bracket, have invested Rs 5 lakh in Liquid Funds and a savings account. Let us consider a rate of return standing at 8% and 6% respectively. Assuming that you opted for the growth option, your tax rate stands at about 31% approximately. Ultimately, what percolates to you post deducting tax is over and above Rs 27,000. However, with the savings bank account, you are left with close to Rs 20,000.
Higher returns:It’s not just about the tax-friendly status of Liquid Funds. On average, such Funds have given higher returns over bank deposits. This is because bank deposit rates are fixed while the returns for Liquid Funds fluctuate to capture the market interest rates. Depending on sentiment and other timely factors, interest rates often climb over the 4-6% offered by bank deposits. Fund managers are thus capable of taking advantage of these rates to give higher returns.
Playing the devil’s advocate:There’s another perspective of looking at this. You enter into a 180-day fixed deposit with an interest rate 8%, but post one month the bank revises the rate to 6% for all the future customers. Fortunately, you will still be entitled to receive an interest at 8%. With a Liquid Fund, however, things do not work the same way. The interest rate in the second month might not be the same as the first. Despite that, if you are looking for better post-tax returns, a Liquid Fund is the one to be opted. Bottomline:Considering you are a high tax payer and belong to the last bracket, the rate at which your bank deposits are taxed does not pay you significantly. On the other hand, a Liquid Fund ensures a certain amount of taxation while taking your tax payment and interest rate into consideration. Understanding tax treatment differs in the case of a bank deposit and a Liquid Fund, it is still important to understand what percolates to you post the tax deduction.