Debt funds vs fixed deposits: how the tax works and when it is paid
A fixed deposit and a debt fund are now taxed at the same slab rate. They are taxed at different times, and that changes how much is left at the end.
Updated 23 Oct 2026 · 5 min read
How FD interest is taxed
Interest on a fixed deposit is added to your income and taxed at your slab rate in each year it is earned. That includes a cumulative FD, which pays everything at maturity: each year's interest is taxable in that year, though you have not received it.
Part of the interest goes in tax every year, and only the rest keeps compounding. At 7% interest and a 30% slab (31.2% with cess), a deposit whose tax is paid from the interest grows at about 4.8% a year.
TDS on FD interest
Banks deduct TDS of 10% each year, cumulative FDs included, once the interest from one bank passes ₹50,000 in a financial year, or ₹1 lakh for senior citizens (limits from April 2025). If your slab rate is higher, the rest is paid through advance tax or when you file. If no tax is due on your total income for the year, a declaration in Form 121 (which replaced Forms 15G and 15H from April 2026) stops the deduction.
How a debt fund is taxed
A debt fund or liquid fund in the Growth option pays nothing out. Its earnings raise the NAV, and there is no tax while you hold the units. The whole gain stays invested and compounds until you sell.
When you sell, the gain on units bought on or after 1 April 2023 is added to your income for that year and taxed at your slab rate, however long you held them. Units bought before 1 April 2023 and held more than 24 months are taxed at 12.5%. How mutual fund gains are taxed has the rules for every kind of fund.
- You choose the year the tax falls in. If you redeem in a year with lower income, such as a year off work or after retirement, the slab rate on the gain can be lower than it is today.
- Withdrawals are taxed only on the gain. With a systematic withdrawal plan (SWP), each withdrawal is partly your original money and partly gain, and only the gain part is taxed. STP and SWP explains how withdrawals are set up.
- No TDS for residents. Nothing is deducted on redemption. Any tax due is paid through advance tax or when you file.
Same slab rate, paid at a different time
Until March 2023, gains on debt fund units held more than three years were taxed at 20% after indexation, which usually brought the tax well below the slab rate. Units bought since 1 April 2023 are taxed at the same slab rate as FD interest. The difference now is when the tax is paid: on an FD every year, on a debt fund once, in the year you sell.
A worked example
Take ₹10 lakh in each, both earning 7% a year: the FD's interest rate, and the debt fund's return after its expenses. The slab is 30%, or 31.2% with the 4% cess. The FD's tax is paid out of the interest each year. The debt fund is sold at the end, in a year when the gain is taxed at 30% or at 5%.
| Years | FD after tax | Debt fund, sold in a 30% year | Debt fund, sold in a 5% year |
|---|---|---|---|
| 3 | ₹11,51,550 | ₹11,54,830 | ₹12,13,341 |
| 5 | ₹12,65,138 | ₹12,76,956 | ₹13,81,619 |
| 10 | ₹16,00,574 | ₹16,65,400 | ₹19,16,859 |
At the same 30% rate, the debt fund ends ₹3,280 higher after 3 years, ₹11,818 after 5 and ₹64,826 after 10. The gap is the tax money that stayed invested until the sale. When the sale falls in a 5% year, the tax is lower as well as later, and the gap after 10 years is ₹3,16,285.
The FD vs debt fund calculator works it out for your amount, rate and slab.
Other differences between the two
- Deposit insurance. FDs are insured by DICGC up to ₹5 lakh per depositor per bank, principal and interest together. Debt funds are not insured.
- Changes in value. A debt fund's NAV can fall: bond prices drop when interest rates rise (interest-rate risk), and a borrower can fail to repay (credit risk). Liquid and overnight funds hold very short-term instruments, so their NAVs move the least.
- Taking money out early. Breaking an FD before maturity usually means a lower rate than the one agreed. Liquid funds charge a small exit load on units redeemed within seven days; other debt funds set their own, and many charge none.
- A deduction for senior citizens. Under the old tax regime, senior citizens can deduct up to ₹50,000 a year of interest on bank and post office deposits, FD interest included. Debt fund gains get no such deduction.
Arbitrage funds
Arbitrage funds keep at least 65% in Indian shares, with each position matched by a sale in the futures market. The share holding makes them equity-oriented for tax: 20% on gains from units held 12 months or less, and 12.5% on long-term gains above ₹1.25 lakh a year after that. Some people use them to park money. Their returns depend on the gap between share and futures prices, which changes every month.
Questions
Is a debt fund taxed at a lower rate than an FD?
Not for units bought on or after 1 April 2023. Both are taxed at your slab rate. FD interest is taxed every year as it builds up, and a debt fund's gain is taxed once, when you sell.
Is tax due every year on a cumulative FD?
Yes. The interest that builds up each year is taxable in that year, though it is paid only at maturity. Banks deduct TDS on it once it passes the yearly limit.
Is TDS deducted when I redeem a debt fund?
Not for resident investors. Any tax on the gain is paid through advance tax or when you file your return.
Are debt funds covered by deposit insurance?
No. DICGC insurance covers bank deposits up to ₹5 lakh per depositor per bank. A debt fund's NAV can rise or fall.
Each fund page has its returns, risk, costs, managers and everything it holds.
This guide explains how things work. It is not investment, tax or legal advice. Rules change; check the fund house's documents, and a qualified adviser for your own case.