Options for Senior Citizens: Fixed income options for lower tax bracket

Interests on deposits are taxable under the head “other income” at the marginal slab rate, similar to coupon from bonds.

By Joydeep Sen

As per the earlier (and still existing) tax slab, income up to Rs 10 lakh per financial year is taxable at 20% and income up to Rs 5 lakh is taxable at 5%. In the new tax slab, which is optional, income less than Rs 15 lakh per financial year is taxable at 25% and income up to Rs 12.5 lakh is at 20%. There are senior citizens who do not have active income other than their savings/ investments, there are young people who are in the initial phase of their career, etc., who are in a tax bracket less than 30%. While the equation is simple, you pay tax on your returns from investments at your marginal tax rate, e.g., 30%, 20%, etc.

We will discuss some perspectives here.

Regular bonds
Coupon (i.e., interest) from bonds is taxable at the marginal slab rate. There is no set-off like in case of capital gains tax. If the tax rate is lower, the effective net-of-tax return from bond investments is that much better and there is an efficiency for people in a lower tax bracket.

Tax-free bonds
These are not efficient for people in a relatively lower tax bracket. The coupon on tax-free bonds is free from tax. The efficiency of this instrument kicks in at a higher tax slab. The logic is, if you invested in a comparable-quality taxable bond, you would pay tax at your marginal rate, which you are saving in a tax-free bond. However, if you are in a lower tax bracket, your tax savings would not be as much.

Post office schemes
Though there was a confusion just before the start of the financial year, interest rates for small savings schemes have been maintained, at least for the time being. Anybody can avail of it, but people in a lower tax bracket would get a better net-of-tax return. Senior Citizen Saving Scheme at 7.4%, Sukanya Samriddhi Account 7.6%, National Savings Certificate at 6.8% are attractive.

Bank / corporate deposits
Interests on deposits are taxable under the head “other income” at the marginal slab rate, similar to coupon from bonds. Lower the slab rate, higher is the effective net-of-tax return.

Pradhan Mantri Vaya Vandana Yojana (PMVVY)
Returns from Pradhan Mantri Vaya Vandana Yojana are taxable as interest at the marginal rate. A pension of 7.4% payable monthly, for the full policy term of 10 years for policies purchased till March 31, 2022, is really sweet, meant for senior citizens.

RBI Savings Bond
The floating rate RBI Savings Bond has the same tax treatment, i.e., at your marginal rate. The rate, currently at 7.15%, is handsome.

Debt MF dividend option
Dividends from mutual fund schemes are now taxable in the hands of the investor, which used to be a defined-rate dividend distribution tax (DDT) earlier. Tax on MF dividends received is at the marginal rate of tax, which obviously will be lower for people in a lower tax bracket. Short-term capital gains tax on debt mutual funds, in the growth option of the fund, is for a holding period less than three years. This is at the marginal slab rate, hence here also there is an advantage for people in a lower bracket. Long-term capital gains tax in debt funds, for a holding period of more than three years, is at a defined rate. However, with the benefit of indexation, the effective tax rate comes down drastically.

Conclusion
Any interest income that is taxable at the marginal slab rate would lead to tax efficiencies, with the exception of tax-free bonds. So look at the SLR of these investments—safety, liquidity and returns.

The writer is a corporate trainer (debt markets) and an author