Are you making the most of your money in Savings Account?

For most people, a savings bank account is the default choice when it comes to the options to park their money for the short term. Other popular one being short-term fixed deposits.

But many times, savers end up leaving excess amounts in their bank accounts for various reasons or the other.

I understand that if it’s for some short-term goal or expense, then it makes sense. But given that the interest rates on most banks’ savings account are nothing to write off, it’s a no brainer that this type of account is unsuitable for parking money for long term.

As the name suggests, it’s a savings account and not an investment account. That should be remembered.

Read that again.

If you do a saving bank interest rates comparison, you will find that the savings account interest rates are mostly 3.5% to 4% but can go up to 7%. The actual rate you are offered depends on the bank you are dealing with and the amount you wish to park.

Presently, if you were to search for which bank gives the highest interest rate on the saving account, then chances are that the rates on offer would be about 7.5% (for amounts exceeding some threshold).

As for historical savings account interest rates – till 2010, the interest rate on savings accounts was 3.5%. But in 2011, the Reserve Bank of India or RBI deregulated the interest rate on savings accounts. Banks could then set their own interest rates. But the general trend has been to offer about 3.5% to 4% by most major banks. Some newer and aggressive banks offer higher interest rates of 6-7%.

How much money should you keep in Savings Account? 

Good question. 🙂

But there is no standard formula for this.

A reasonable amount should be kept. If you were to ask me what exactly do I mean by ‘reasonable’, I would say that an amount equal to 1 to 3 month’s worth of expenses should be fine. Whatever gives you reasonable levels of peace of mind.

Ofcourse if some near term expenses are approaching, then the amount in savings account can be much higher.

But there is no reason to keep a high savings account balance on a regular basis. More so in the era of zero balance account and unless you are an ultra-conservative investor, it will mean you will lose out on higher returns that could have been generated by parking your money elsewhere.

For the sake of completeness and because many are unaware, let me tell in brief how the interest on Saving Bank account is calculated?

The interest is calculated on the daily balance in your account. But the total interest is credited to the account only quarterly.

Taxation of Interest from Savings Account

Since you are parking money with the bank, it will pay you interest. This interest is an income for you and hence, should be taxed.

But our respected Income Tax Department gives a deduction of up to Rs 10,000 under the Section 80TTA on interest earned from all your saving bank accounts in a financial year.

What about interest exceeding Rs 10,000 per financial year?

It will be taxed.

So, if your interest income from the savings accounts is Rs 7000, you don’t have to pay any tax on it. But if it is Rs.14,000, you need to pay income tax on Rs 4,000 according to your tax slab.

Remember, the deduction available under section 80TTA is only applicable to interest earned from Savings Account and not on interest earned from fixed deposits or term deposits.

Also, this deduction is available on interest income from ALL savings bank accounts. So you cannot have Rs 10,000 deduction for interest from each of your saving accounts.

So how much money should be kept in your savings account(s) to earn Rs 10,000 in tax-free interest?

It will depend on the interest rate on offer like this:

• At 4% interest, amount to be kept in savings account is Rs 2.5 lac
• At 5% interest, amount to be kept in savings account is Rs 2.0 lac
• At 6% interest, amount to be kept in savings account is Rs 1.66 lac

So if you are keeping a few month’s worth of expenses in Savings Account, then the amount will generally be tax-free. This is assuming your expenses are not extremely high. 😉

And since we are talking about taxes, let me tell you that Tax Saving should not be your blind priority.

Your life is about your real financial goals and money should help you achieve them. And efficient tax saving is a positive side effect of a Smart Goal-based Financial Plan that helps you achieve your life goals.

Good alternatives to Savings Account?

 Is the there a better option to earn somewhat higher returns than keeping money in savings account?

One decent option is Liquid Fund – a type of low-risk debt fund (read more about Mutual Fund category changes).

These are open-ended mutual fund debt schemes which have a very short-term investment horizon. These invest in money market instruments like the certificate of deposit, treasury bills and commercial papers of up to 91 days.

Infact, these days you will see a lot of promotion around Liquid Funds vs Savings Account kind of theme.

Let’s try to briefly understand whether Liquid Fund is really a good alternative to Savings Account or not.

In 2017, the returns delivered by Liquid funds were about 6.5%. But in years preceding 2017, the returns ranged from 7.5% to 9% for good liquid funds. So by putting money in Liquid funds, you are more likely to get returns higher than the basic savings account. Even the post-tax returns are likely to be more than that of savings accounts.

But remember that unlike savings account, the returns of Liquid Funds are not guaranteed. They fluctuate. Not much but still they do. These are low-risk products and not zero-risk products.

And there have been cases where poorly managed liquid funds saw their NAV crash by more than 7% in a day! Search google and you will find this incident.

So I repeat – Returns from liquid funds are expected to be higher than the savings account but are not guaranteed.

But that’s how it should be – Isn’t it?

In your search for higher returns (than savings account), you are taking higher risk. So the risk of being wrong will always be there. It’s a fair deal.

That was about the returns.

What about liquidity?

Since we are comparing with savings account, liquidity should be discussed.

Liquid funds are fairly liquid(!) but you will usually get your money in T+1 days. So in a situation where you need the money ‘right now’, you will remember the liquidity offered by the savings account – and which is one of the reasons why people park money in those accounts.

So if you understand the above basic points about the liquid funds and are willing to accept the small risks, then liquid fund can be a good alternative for the savings account. But even then, having some money in savings bank account makes sense for immediate liquidity (emergency) and simplicity needs.

But if you are not comfortable with these, then stick with savings account or short term FDs. In any case, you should not be parking a vary large amount in it for long time. So chances of big interest loss are low.

Infact to keep things simple, you can even opt for your bank’s Sweep-In FD facility. It works like this that you can set a threshold limit for your savings account, above which any amount deposited will automatically be moved into a fixed deposit to earn higher interest. Plain and simple.

But you have to pay income tax on interest income from FD every year. Compare this with money kept in savings account where interest of Rs 10,000 per year is not taxable as per Section 80TTA of the Income Tax Act. Also compare this with debt funds, where you will pay tax only when you sell your MF units. So if you end up holding your units for 3+ years, then your gains will be taxed at 20% after indexation – which most often works out much better than pure savings account returns.

Using Savings Account for Emergency Fund?

Yes, atleast a part of it.

It makes sense to have atleast 6 month’s worth of basic expenses in your emergency fund. You already know what emergency funds are for.

Now the first thing to remember about an emergency fund is that it is to tackle emergencies and not to earn high returns (by taking higher risks). Read that again.

From liquidity perspective, there can be a case for putting all of the Emergency fund in savings account. But if your emergency fund size is big enough (like equal to 6 months worth of expense), then you can have a tiered structure in place. for example:

• Savings Account
• Fixed Deposits with instant liquidation facility
• Liquid funds

This way, you will earn much higher than a pure savings account and have enough liquidity at hand from a practical perspective. The exact allocation between these 3 tiers can vary and depend on person’s comfort level and individual situation.

But have atleast 1-1.5 month’s worth in savings account. The remaining fund can be divided into the other two. And if you are beginning to build your emergency fund, it makes sense to keep it simple and have higher initial allocation towards savings account + FD. Later on, even a not-so-evil credit card can help you smoothen out your cash flows.

Finally…

To be honest, there is not much to write about savings account. People use it as it is their default choice to park/receive money, is easy, offers ‘some’ interest and lots of liquidity to them.

Is there a perfect formula about how much money to keep in savings account?

Yes.

You should keep as much in savings account as you are reasonably comfortable with but not too comfortable with. 🙂

Sorry… there is no formula. Though you can take your hints from the section above where we discussed how savings account can be a part of the emergency fund.