Recurring Deposits: Tax and Interest Rates

by Manshu on August 19, 2011

in Fixed Deposits

This is another post from the Suggest a Topic page, and this time we’re going to take a look at Recurring Deposits.

The original comment had a question on how tax is calculated on recurring deposits, and unfortunately I didn’t get any authoritative information on that. I did speak to one person who described how this will be calculated, but he wasn’t entirely certain himself.

So I will describe the tax on recurring deposits based on what he told me, and my own understanding and interpretation of what he said. I don’t know how accurate this is and if any of you have any good links or have practical experience, please do leave a comment.

Tax on Recurring Deposits

First, what I do know for sure – RDs are not tax free!

While doing research for this article I came across a few forums where people were asking if interest income from RDs is tax free or not. I don’t know what the origin for the question is but it could be people confusing no TDS with any tax at all.

Banks don’t deduct tax at source on RDs but the interest itself is taxable like other interest income. It will be added to the rest of your income and taxed at your slab.

This is what I think will happen

If you take a RD for the duration of over a year, say 2 years – then you will have to see how much interest accrues to you in one financial year, and then declare that interest as part of your return and pay tax on it.

So, even though you are still paying installments for the RD, and it hasn’t matured yet, you will need to declare the income that has accrued to you, and pay tax on it.

You add the interest income to your salary, and then pay tax on your regular tax rate. The interest earned can be calculated using a calculator such as the one on the Corporation Bank website.  

Let me reiterate that  I have never done this myself, and I am not a 100% certain if this is the right way or not – please do leave a comment if you know otherwise.

Here are some other things I found about RDs.

Interest rates on Recurring Deposits

I was going through the interest rate page of ICICI Bank, and saw that they give interest rates of 8.25% on RDs of 12, 15, 18, and 21 months, but they give 9.25% on a 390 day fixed deposit.

A few other bank websites said that they offered RDs at the same interest rate as the fixed deposit, but I think that means exclusion of special interest rates that banks give on deposits of 390, 555, 400 day maturities etc., and since these are the maturities that give you the higher interest rate, it looks like the interest on a RD will be lower than a fixed deposit.

Effect of Direct Tax Code on Recurring Deposits

I’ve seen that sooner or later someone comes along and asks how DTC will affect a particular product, so I thought to include this here.

There are no tax benefits of investing in RDs, they aren’t covered under Section 80C, and the interest is not tax free either. So, there are no tax benefits of investing RDs that will be affected negatively by the DTC. The tax slabs will change in DTC, and since interest income from RDs are going to be taxed according to your income slab – that’s the only effect that DTC will have on RD. In my opinion, this is not material or something that will make a difference in your decision to opt for a RD or not.

Stopping Recurring Deposits Early

Banks allow you to stop your recurring deposit earlier than the maturity period, but like fixed deposits, you get a lower interest rate than what you have settled for, and in some cases there is some penalty as well, which is also called a service charge in some banks.

Conclusion

In my mind, the difference in interest rates makes the fixed deposit a better option than a recurring deposit, and probably the only reason to do a recurring deposit is to get into the habit of saving and putting aside a fixed sum every month. Even so, I think shorter dated RDs are much better than longer dated ones because after a year or so you can take the maturity amount and open a fixed deposit where you will get a better return.

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