4 ways to fight savings rate cut

Do you let your monthly pay cheque land straight into your savings account and idle there for months before you invest or spend it? Do you keep your emergency money in a savings bank account?

The cost of doing both has just shot up sharply, thanks to the largest Indian bank cutting its savings account interest rate from a modest 4 per cent to a measly 3.5 per cent. Don’t be surprised if other banks follow suit.

We all know that the rock-bottom inflation rates that we’ve seen lately are unlikely to last. So, at an average consumer inflation rate of 6 per cent, parking money at 3.5 per cent means losing 2.5 per cent of your savings to the inflation monster every year.

So, here are four ways to earn a better return on your surpluses and emergency money.

While the large public sector banks are flush with funds after the note ban, prompting them to slash rates, newly licensed private banks and regional players are keen to woo new account holders.

That’s why YES Bank (6 per cent on balances up to ₹1 crore), Kotak Mahindra Bank (6 per cent) or RBL Bank (5.5 per cent on balances up to ₹1 lakh) continue to offer much higher rates on savings bank accounts.

If safety concerns have been making you cling to your vintage public sector bank, do note that the deposit insurance coverage in India is exactly the same both for private banks and public sector ones, as long as you are dealing with an RBI-registered commercial bank. In fact, more public sector banks are in a shaky financial position today than the new private sector ones, due to their legacy bad loans.

The advantage of opening an account with the newbie banks is that you may be wooed with attractive freebies.

The freebies may include zero balance accounts for you and your family, locker facilities, free ATM withdrawals, free insurance with your debit card, sweep facilities, cash-back on debit cards spends and discounts on locker rentals.

Presently, only ₹10,000 of the annual interest income you receive from your savings bank accounts is exempt from tax. This effectively means that, at a 5 per cent interest, you can hold roughly ₹2 lakh as the average daily balance across all your savings account to escape tax.

If you’re prone to holding more than this, you will need to explore other options that either improve your returns or reduce tax.

One hassle-free way to improve your returns, while staying with the safety of your bank, would be to set up a sweep facility with your bank. Sweep-out facilities allow you to leave standing instructions with your banker to immediately move all the excess money into a fixed deposit (FD), if your account balance exceeds a certain limit. You can set this limit.

Most new-age banks offer sweep-in facilities along with sweep-outs, allowing you to break the FD through online banking in case of emergencies.

But the flip side of sweeps is that you lose the ability to choose the best tenures and rates while creating the FD. FD interest is also subject to tax at your slab rate; TDS is also applicable.

Ever noticed how deposit rates are so slow to move up when market rates are rising? With interest rates close to bottoming out right now, parking your surpluses in vehicles whose returns will float up with the market is a wise move.

Liquid and money market mutual funds deliver this ‘floating rate’ benefit. Both liquid funds and money market funds are mandated to invest in debt instruments with a maturity of less than 91 days. They invest in treasury bills, bank wholesale deposits, public sector bonds and commercial paper issued by companies. They’ve averaged an 8 per cent return in the last five years, but given the recent dip in rates, a 6-6.5 per cent expectation would be more realistic now.

Fund houses such as Reliance Nippon (Simply Save), Birla Sun Life (Active Account) and ICICI Pru (iSave) now offer smartphone apps that automate your liquid fund investments. So, it is possible to link your savings bank account to the fund for an instant transfer of money into a liquid fund. Sign up for one of them and make your investments easy.

When choosing your liquid funds, don’t opt for those with the highest returns (those are the most risky as well), but go for those with the lowest corporate exposure in their portfolio.

Specially designated money market funds and liquid funds with only sovereign or PSU exposure may be your safest bets.

The Growth options of liquid/money market funds are tax-efficient if held for a minimum three years. They allow you to claim indexation benefits on your accumulated returns.

If you fall in the top tax bracket, returns on your liquid fund investments are taxed at high rates if you withdraw before three years (dividends at 28.3 per cent and capital gains at slab rates). For you, arbitrage mutual funds are a good parking option.

Arbitrage funds are low-risk mutual funds that make money from betting on the spreads between the cash and future contracts on stocks (Refer Are Arbitrage Funds Still Worth It? for details on how they work).

Because arbitrage funds track short-term borrowing costs in the market, you can expect their returns to hover in the 6-7 per cent range in the near term. These will also float up or down depending on market interest rates. Returns on arbitrage funds are presently completely tax-free after one year.

Look for arbitrage funds with a three-year record and make it a regular habit to sweep money from your savings account into these funds.