How can opting for SWPs in mutual funds over FDs reduce your tax liability?

While investing in fixed deposits (FDs) may seem easy, it’s vital to consider the tax implications. FD interest income is taxed according to your tax slab, which could be as high as 30 per cent given your tax slab. For instance, if you invest Rs 20 lakh and earn Rs 35,000 each quarter at a 7 per cent interest rate, you’d have to pay total Rs 42,000 in taxes at the 30 per cent tax rate (35,000x.30x4).

But fear not! There’s a smart way to cut down your tax liability using Systematic Withdrawal Plan (SWP). SWP lets you withdraw a fixed amount regularly from a mutual fund, and it’s the opposite of Systematic Investment Plan (SIP). The tax liability is much lower in SWP because the tax computation differs between the two. In case of mutual funds tax is levied only on the capital gains, which is calculated as per NAV at the time of buying and selling the units. On the other hand, FD interest income is entirely taxable.

Suppose you invest the same Rs 20 lakh in a debt mutual fund with an NAV of Rs 40 and choose quarterly withdrawal of Rs 35,000. In the first quarter, you'd redeem 860 units, with a capital gains tax of Rs 176. Repeating this for the other three quarters, your yearly capital gains amount to Rs 5,772, with a tax liability of just Rs 1,731- which is a way lower than Rs 42,000 you paid in taxes in FDs!

How taxation works in debt mutual funds through SWP

 

Before opting for SWP, remember that FD interest rates remain fixed, while debt fund returns fluctuate due to interest and credit risks. So, carefully analyze the tax benefits. To maximize advantages, diversify between FDs and debt funds, and prefer AAA-rated instruments for stable returns and minimal tax burden.

To sum up, when comparing SWP and FD as investment options, the key differentiating factor lies in their tax treatment and flexibility. FDs attract taxes on the entire interest income based on your tax slab, leading to potential higher tax liability. In contrast, SWP allows you to withdraw a fixed amount from a mutual fund, and tax liability arises only on the capital gains component, potentially resulting in lower taxes. While FDs offer stability and fixed returns, SWP provides greater flexibility, allowing you to adjust withdrawals as needed. Ultimately, the choice between SWP and FD depends on your risk tolerance, investment horizon, and tax-saving objectives.