FD or debt fund: which leaves more after tax?

The question, with the return held equal

People compare an FD with a debt fund by quoting a rate for each, which mixes two different questions: which pays more, and which is taxed less. This post isolates the second. It assumes both earn the same 7% a year and that you are in the 30% slab with 4% cess (31.2%). Any gap that remains is purely tax timing.

How each is taxed

• FD: the interest accrues every year and is added to your income every year, whether or not you withdraw it. Banks deduct TDS once interest crosses a threshold, but your tax is due at your slab rate regardless.
• Debt fund (units bought on or after 1 April 2023): nothing is taxed while you hold. The gain, the difference between sale value and cost, is taxed at your slab rate in the year you redeem. See how debt and hybrid funds are taxed.

Same rate on the gain, different timing. The FD pays tax every year out of the money that would have compounded; the fund pays once, at the end.

₹10 lakh at 7%, 31.2% tax

The FD's post-tax return works out to 4.82% a year (7% × (1 − 0.312)), and that smaller base is what compounds. The fund compounds the full 7% and pays the tax at the end. The longer the holding, the more the deferral is worth, which is why the gap grows faster than the years.

Two things this table deliberately leaves out, and both cut against the fund: a debt fund's expense ratio comes out of its return, and a real fund's return is not a straight line. Our FD vs debt fund calculator lets you set a different return for each.

When the FD still wins

• Certainty of the number. An FD's rate is fixed for the term; a fund's return is whatever the bonds do.
• Insurance. Deposits are covered by DICGC up to ₹5 lakh per depositor per bank. A fund has no such cover.
• Short money. Under about three years the tax edge is a few thousand rupees, easily lost to a bad quarter in bond prices or to the expense ratio.
• A lower slab. If you pay little or no tax, deferral is worth little and the FD's simplicity wins.

When the fund earns its place

Large sums held for years by someone in a high slab, where deferral compounds, and where you can tolerate a NAV that moves. Pick the fund type to match the horizon, as the post on time-horizon buckets lays out: a liquid or ultra-short fund for months, a short-duration or corporate bond fund for a few years. Emergency money belongs in neither if you cannot stand a dip; see the emergency fund guide.

This post is educational, not financial advice. Rates, slabs and tax rules change; the figures assume a 7% return and a 31.2% effective rate and ignore surcharge, expense ratio and TDS timing.