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How Is Interest Calculated On Savings Account Balance?

All savings bank accounts offer interest on the balance on a daily basis. The average balance will be taken, so that at any point of time the account holder gets 3.5 per cent annually. Example: You have zero balance in your account at the start of the month. Your salary worth `50,000 is credited to the account on the 1st. You withdraw `25,000 on the 5th.

The available balance on the 10th is `25,000. We assume there is no more payment and only one withdrawal of another `10,000 on the 20th of the month. This will lead to an interest payment on `50,000 for five days (1st to the 5th of the month), then on 25,000 for 15 days (5th to the 20th of the month) and last, on 15,000 for 10 days (20th to the 30th of the month). Therefore, the total interest earned on various available balances will amount to `75. The balance at the end of each day would be utilised for the calculating the final interest received by the account holder. This is called the daily balance method.

How beneficial is this method?

Last April, the Reserve Bank of India had asked banks to start calculating interest on savings accounts on a daily basis, starting April 1. Earlier, banks computed interest on the lowest available balance in the account, between the 10th and the last date of any month. If you withdrew a certain amount from your account on the last day of a month, the interest was lost for the entire month. A deposit made during this period would not be counted either, as a higher balance did not matter for the interest computation. This led to low interest in spite of a high balance. Taking the above mentioned example, the balance on the 10th of the month is `25,000.

There is a reduction in the account balance by 10,000 by the 20th of the month. Hence, the balance used for calculating interest is `15,000 and the interest for the month will be `44, lower than what you earned under the present norm. With the present method, the account holder need not worry about the date of fund deposit or withdrawal.

How is the interest taxed?

Interest earned on the balance in your savings account is taxable under the "income from other sources" head. For individuals, this amount needs to be added to their salary and taxed according to the income tax slab. If the tax liability is more than 10,000, it needs to be disclosed. In case this is not done, one can go for self-assessment. But this would require payment of advance tax.

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