Question: You make Rs. 9 lakh a year and as an investment put Rs. 2 lakh in a Fixed Deposit with a bank in India which pays 9% interest compounded quarterly. What is the percentage of return you get after 1 year? 9% or 7.4%?
The answer is B or 7.4%. Surprised?
What you probably didn’t consider was the tax charged on the interest you earn which is calculated based on your prevailing tax slab. So if you fall in the 20% tax slab (which you will normally, if you make Rs. 9 lakh/year), your interest earned will be taxed at the same rate.
What this means is that while normally you would have expected to earn roughly Rs. 18,616.6 as interest, you actually earn Rs. 14,893.3.
While FDs might be considered safe, the returns they provide are not tax efficient. Considering inflation over the long run hovers around 8-8.5%, you actually lost money in real terms.