Defer taxes to power compounding!

Last Updated on

A financial instrument that lets you defer paying taxes until maturity is way superior to one where you need to report and pay tax on the income generated each year of investment. That is the single most important reason why debt mutual funds are superior to fixed deposits.  This is an illustration of the power of compounding with deferred taxation, suggested by subra(

I have already illustrated this point here: Budget 2014: Debt Mutual Funds vs. Fixed Deposits and in other posts. Subra felt it would nice to have a generic deferred taxation calculator and hence this post.

First let us look fixed deposits alone. There are two ways in which you can pay taxs: (1) pay each year, (2) pay upon maturity.  A court has ruled that every citizen has a right to choose the style of accounting and taxation – pat each year or upon maturity. However, they cannot change style once made.  More details about this with documentation can be found here: Debt Mutual Fund vs. Fixed Deposit Comparator – Version II

Unfortunately FDs and RDs have TDS. This means that even if you choose to pay tax upon maturity, 10.3% tax as TDS would get deducted each financial year.  Therefore it would be a mess to split the taxation in two different ways – TDS, and maturity) from the point of view of ITR. In todays connected world, the ITO is already serving up pre-filled ITR forms. The banks have our PAN no and we declare bank details while filing.

So sooner or later, the TDS would be an auot-filled entry when we set to file ITR. Therefore, deferring tax on FD until maturity can be a nightmare if the IT dept senses a red flag and calls an enquiry. One may quote rules, but there is no guarantee that the assessing officer would buy that.

Conclusion: Even if you don’t have to, it is prudent to pay tax on FD interest each year.

As a simple illustration of the power of compounding with deferred taxes, consider a fixed deposit where gains are taxed as per slab with no TDS.

For an individual in the 30% slab investing 1,00,000 in a (hypotherical) 20 year(FY) old fixed deposit at 8% return compounded annually, the final corpus

  1. by deferring tax upto maturiy is 3,52,972
  2. by paying tax each financial year is 2,93328

A difference of 59,644 or about 20% more. This is simply because, by paying tax on the gans each year, the amount left to compound is lesser. Higher the duration, more would be the impact.


Note: It is innumeracy to argue that the FD grows untouched and  I paying taxes out of a different pocket and not distrubing the compounding.

Now  instead of a fixed deposit, had a debt fund been chosen, 8% before tax is a pretty reasonable return over 20 years.  Before 3 years (if redeemed) the gains would be taxed like a fixed deposit – added to income and taxed per slab.

After 3 years, the tax rateis 20.6% and the gains will have to be calculated after hiking the investment amount by the cost inflation index. For the present illustration we will assume that cost inflation index grows each year at the rate of 5% (again reasonable).

So we have,

  1. by paying tax each financial year, the 2o-year FD maturity value  is 2,93328
  2. by deferring taxes until redemption and using indexed capital gains for taxation, the maturity value with a debt fund is, 4,24,738.

A difference of 1,31,410 – deferring taxes and taking advantage of the lower tax slab results in a significant difference (~ 45%) in corpus.


These illustatrions may seem obvious to you.

Now what if the tax slab of the person was 10% for the next 20 years? Entirely possible for a retiree. Should such a person invest in fixed deposits or in debt funds?

For each of those 20 years, the FD would be taxed at 10%. For the first 3 years, the debt fund would be taxed at 10% and then 20% with indexation (when redeemed).

As counterintuitive as it seems, the debt fund is better!

For 1,00,000 invested, the FD (with 10% tax paid out each year) would yield, 3,99,900

The debt after 20 years (with 20% tax on indexed gains) would yield 4,24,738.

This is only a 6% difference and once argue the comfort of FDs is better  for those in the 10% slab. I agree with that. However, I think it is clear that deferring taxes powers compounding.

Here is a calculator with which you can play around to get a feel for this idea.

Download the power of compounding with deferred taxation calculator

Do share if you found this useful

About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; where to invest; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. I can do the talk via conferencing software, so there is no cost for your company. If you want me to travel, you need to cover my airfare (I live in Chennai)

Connect with us on social media

Content Policy

Freefincal has original unbiased, conflict-of-interest-free,  topical reports, reviews, commentary and analysis on all aspects of personal finance like mutual funds, stocks, insurance etc. All guest authors and contributors to the site also do not have any conflict of interest. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. No promotional content We do not accept sponsored posts and link exchange requests from content writers and agencies. This is our privacy policy Our website is non-profit in nature. The revenue from the advertisement will only be used for hosting charges, domain registration charges, specific plugins necessary for traffic growth and analytics services for search engine optimisation.

Do check out my books

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingMy first book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.  It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You WantGamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantMy second book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

The ultimate guide to travel by Pranav Surya

Travel-Training-Kit-Cover This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.

1 Comment

  1. Great Article. But, the file crashes when opened and when changing the tax slab. I have tried saving it as Excel 2013 format with Macros still it crashes. Can you please recreate the file with Excel 2013 extension?

Leave a Reply

Your email address will not be published. Required fields are marked *