Tax Exempt Interest Income

Not all interest income is taxable. Tax exempt interest income can make this a reality, you may earn interest on your hard-earned money without having to share some of that interest with the government. It is one of those financial benefits — if done right — that can have you boost your savings and lower a tax bill.

But are you making the most out of it?

There’s so much confusion surrounding what constitutes tax-exempt interest, who’s entitled to it and how all of this works, we are here to simplify the topic for you.

Whether you are strategizing your investments or simply have interest in more intelligent money management, this guide will explain everything you need to know about tax exempt interest income.

What Is Tax Exempt Interest Income?

Tax free interest income is the interest received from some investments which are not subject to taxation. Sounds great, right? But here’s the thing—not all interest income is covered here.

Such exemptions are usually conditional as defined in India’s Income Tax Act, 1961.

For example, Section 10 provisions or municipal bonds in certain geographies are examples of government-approved instruments that often generate this type of income.

The main goal? To get people to invest in sectors that are favorable to the government.

How Is It Different from Taxable Interest?

Here’s a quick comparison. Once the interest earned on savings accounts, recurring deposits, and fixed deposits exceeds the exemption limit, it is fully taxable.

Conversely, tax exempt interest income is tax free, so you could have better net returns.

What Investments Generate Tax Exempt Interest Income?

So where can you get tax-free interest — and not pay tax on the income?

Here are some options to consider –

1. Statutory Provident Fund (SPF) and Recognized Provident Fund (RPF): The interest earned on SPF balances has been exempt under Section 10(11). Further, for RPF, under Section 10(12), 9.5% yearly interest is exempt.
2. Sukanya Samriddhi Yojana: It is a government scheme, that is issued to promote the girl child welfare and its benefits are totally tax-free. All of the deposits, interests, and maturity amounts are tax-free.
3. Interest on Relief Bonds: Some sovereign bonds such as the Reserve Bank of India’s Relief Bonds and other specified securities provide tax-free interest. These are specifically meant for elderly people or folks who prefer less risk.
4. Municipal Bonds and Local Instruments: In some instances, municipal bonds are triple tax exempt, meaning you’re not paying taxes at the federal, state or local level. Check with your city or state policies as exemptions on such bonds may vary in geography.
5. NRE Accounts: For NRIs, the interest you earn in Non-Resident External (NRE) fixed deposit accounts is completely exempt from taxes, as long as your residential status doesn’t change.

What Is the Interest Exemption Limit?

These exemption limits can differently apply to different types of financial instruments and also based on the demographic factors (like salaried person, senior citizens, etc.). Understanding interest exemption limit is very important for tax planning purposes. 

Below are notable updates and provisions that explain the current regulations:

For Savings Accounts

The exemption limit under Section 80TTA stands as ₹10,000 annually for savings account holders. This implies that interest earned up to ₹10,000 on your savings account is tax-free. But the rules change with respect to senior citizens, where Section 80TTB grants them a higher exemption of ₹50,000 a year.

Fixed Deposits (FDs)

Currently, with new rules, senior citizens with fixed deposit accounts will be able to get an expanded exemption limit on interest income. 

Effective FY 2025-26, the new limit has been increased from ₹50,000 to ₹1,00,000. 

The adjustment is intended to better assist retirees who depend on more conservative forms of investments.

Interest on Securities

The tax exemption limit on interest income through certain government securities was revised under Section 193. 

The exemption for individual taxpayers under section 80TTA is ₹10,000 per annum, whereas for senior citizens the threshold is ₹1,00,000.

EPF Contributions

Interest earned on contributions to the Employee Provident Fund (EPF) is also tax-free, as long as the total contributions in a year do not exceed ₹2.5 lakh for non-salaried individuals and ₹5 lakh for salaried employees who are covered under employer contributions.

Recurring Deposits (RDs) Interest

Although RDs typically appeal to TDS, senior citizens can now avail of the increased ₹1,00,000 TDS limit recently introduced. 

In other cases, TDS limit remains at ₹40,000.

So if you are a seasoned investor or even just avoiding tax-time headache for the first time, taking advantage of these exemption limits can do wonders for your taxable income. 

How to Claim Exemption on Interest Income?

Let’s break this down for you. 

You can’t close ignore your interest income on your tax return. It has to be correctly reported under the head ‘Income from Other Sources.’

Here’s what to do to make sure you don’t accidentally over pay taxes on your eligible tax-free income.

• Submit Form 15G or 15H: Not making taxable income over exemption levels? To avoid TDS deductions, you can submit Form 15G (for individuals below 60 years) or Form 15H (for senior citizens) at your bank.
• File Excess TDS Refunds: Banks deduct TDS even if your total income is tax exempt at times. Make sure you claim for refund by filing your Income Tax Return (ITR).
• Track Your Investments: Maintain records of tax-free interests. If you are investing in Sukanya Samriddhi or municipal bonds, make sure that you divide taxable and non-taxable income during tax planning.

Still with us? Good, because we’re about to dive into some fascinating examples.

Tax Exempt Interest Income Examples

Example 1: Interest in Savings Accounts

Meera is a salaried employee and earns ₹7,000 as interest from annual savings account. Since the income is below the limit of ₹10,000 under section 80TTA, she does not pay tax on this amount.

Example 2: Interest on Senior Citizen FD

Assuming Mr. Sharma, who is 67 years old, has an annual FD interest income of ₹45,000. All this income is tax-free under Section 80TTB, as it is below ₹50,000 for senior citizens.

Example 3: Sukhya Samriddhi Scheme

Raj and Priya invest ₹1 lakh in Sukanya Samriddhi Yojana for their daughter. Over time, they earn ₹6,500 as interest. This amount remains fully tax-exempt, saving them ₹1,950 (assuming a 30% tax rate)!

Example 4: NRE Fixed Deposit

Amit, an NRI, has opened an NRE fixed deposit in India and receives an interest of ₹1.2 lakh every year. Any interest earned on it is tax-free in India, as long as he retains his NRI status.

Example 5: Municipal Bonds

On buying ₹1 crore of municipal bonds, Anjali earns ₹4 lakh of interest per annum. Under the state and central statutes, she is also qualified for tax-exempt, saving a lot.

AMT — Some interest could cause (Alternate Minimum Tax).

Exemptions apply to municipal bonds only as they vary from state to state.

In brief, tax-free does not mean reporting free: all such income must be reported.

And these nuances must be assessed to avoid surprises.

Is Tax Exempt Interest Income for You?

You may be thinking, “Should I prioritize tax exemption or higher returns?”

The answer depends on your personal investment objective and appetite for risk. 

Tax-free interest is more beneficial to low-risk investors, retirees, and those in higher tax brackets. It is like returning more without putting in a lot of work! 

If cutting your taxes is in line with your strategy, potentially tax-exempt income earning instruments can be a good option.

But, if you are looking for some high return options, then it is worth considering online p2p lending platforms like LenDenClub. Of course, interest income earned from these sources comes under taxation.

Conclusion

In general, tax exempt interest income is a great way to compound your savings and reduce your tax burden. 

You can maximize the financial rewards of having instruments like provident funds, Sukanya Samriddhi Yojana, and municipal bonds.

But here’s the golden rule of stipulations: always check the details. Laws regarding taxes are subject to change, and your eligibility for exemptions will depend on your income, where you live, or what you invest in.

With a little research and strategy, you can convert your savings into an income-generating powerhouse without paying any taxes.