Income Tax on Savings Bank Interest

Income Tax on Savings Bank Interest: Overview

Savings account is an account with a bank or financial institution that offers interest at a decent rate. It is one of the fundamental financial products that everyone must have and make use of. A savings account allows you to save/ transfer/withdraw money along with earning interest on the funds lying in your account. It is one of those rare financial products that offers  dual benefit of liquidity along with interest earned.

Benefits of a Savings Account

It is advisable to deposit excess funds in savings account since it pays interest on deposits, whereas, you earn  no interest from a checking account. Savings account, in fact, is one of the most liquid investments after cash and demand accounts. These accounts offer a platform for savings while keeping your funds easily accessible. On the contrary, it is a tedious task to encash a bond, stocks or other assets. These benefits have been listed below:

  • Security- Savings account provides you assurance that the funds kept in your savings account are free from any risk. It can be availed immediately in case of any emergency.
  • Liquidity- Money deposited in a savings account can be utilized any time. Funds can be withdrawn from bank/ ATM or you can also make hassle free payments using debit cards.
  • Minimum balance- You are allowed to start investing in a savings account with a very low amount. You can thereafter add to this minimum required deposit as per your convenience.
  • Online banking- Banks also provide access to its services like internet banking and phone banking along with the savings account. This not only offers convenience but also guarantees quicker transactions. It would allow you to transfer funds using IMPS or NEFT, payment of bills, linking of credit cards with your savings account and many more such services.

Drawbacks of a Savings Account

Savings account cannot be used as a tool for long term investments since they pay interest at rates lower than certificate of deposits or treasury bills.

How a Savings Account Operates?

Visit your bank or financial institution in order to open a savings account. You may also open a savings account online by visiting the bank’s website. You can avail various services with a savings account such as withdrawal or deposit of money, transfer of funds from one account to another, checking of account balance, automatic deposit or withdrawal from account etc. These services can be availed by visiting the bank, using online services by visiting bank’s website or through ATM.

Minimum required balance in a Savings Account

On opening a savings account you would be informed about the minimum average balance required to be maintained in your account at all times. On going through the fine print of a savings bank account, you would notice that some banks use the term ‘minimum daily balance’ whereas others use ‘minimum quarterly balance’ or only ‘minimum balance’. Average minimum balance refers to the amount that is required to be maintained in the savings account over a specified time frame. Average balance is arrived upon by adding up the closing balance everyday and dividing it by the number days in the stated period.
For instance: If the average daily balance in your account is INR 5,000 for a quarter, the average quarterly balance for that quarter would come out to INR 5,000, irrespective of the fact that you may have held INR 2.70,000 on some day of that quarter.

A non-maintenance penalty would be levied if you do not fulfill the specified minimum balance requirement condition of your bank.

Now a days, nearly all major Indian banks offer Basic Savings Bank Deposit Account (BSBDA). Under BSBDA no penalty would be levied even on non maintenance of minimum required balance. This is basically a zero balance account that can be used just like any other normal savings account without any penalty for minimum balance.

Interest on Savings account

As per the RBI guidelines, banks have to pay interest on quarterly basis or even shorter duration on savings accounts. Presently, interest is calculated on savings account on a daily basis. Central bank has given the liberty to commercial banks to decide the interest rates offered on savings bank deposits.

How interest rates on savings account is calculated?

As per the RBI guidelines, interest on savings account is calculated on a daily basis on the closing balance each day. Although, this interest is calculated on a recurring basis, but it will be credited to your account on a monthly/ quarterly/ half yearly basis (as the case may be).
The below formula is used to calculate interest on a general savings account:
Interest per month = Daily closing balance * Rate of interest * Number of days / (Days in a year)
For instance, if the daily balance is Rs 5 lakhs and the interest offered on savings account is @ 6 per cent per annum, the interest component shall be calculated as follows:
Interest per month = 5 lakhs * .06 * 30 / 365 = INR 2466

Income Tax applicability on Savings Account Interest earned:

The interest component earned on a savings account is accounted under the head ‘Income from Other Sources’. This interest income must be filed under Income Tax Returns and will be taxable as per the applicable slab rates. As per section 19A of the Income Tax Act, 1961, TDS shall not be applicable on a savings account. Interest earned on a savings account beyond INR 10,000 shall attract taxes at marginal rates for the account holder. It is worth noting that the interest on a savings account is not exempt, but, is in fact allowed as deduction.

Deduction is allowed under section 80 TTA of the Income Tax Act, 1961. Only the interest income up to INR 10,000 can be allowed as deduction subject to the condition that the savings account is held with a Post Office or with a recognized public or private bank. This deduction is allowed only to individual and HUF assesses. Maximum Rs 10,000 per year deduction is allowed for interest earned from all savings account held in a bank, post office or co-operative banks. Interest earned beyond Rs 10,000 from any of these sources shall be taxable. For example: Mr. Rishabh earns Rs. 8,500 from interest on savings account. Thus, no tax shall  be payable on these earnings. On the other hand, Mr. Mukul earns Rs 17,000 from his savings accounts. Thus, he would be required to pay tax at the rates applicable as per his tax slab of Rs 7,000.
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