Fixed deposit (FD) is an investment option that allows you to invest a sum of money for a fixed time period and at a fixed rate of interest. During the course of the FD, even if the prevailing interest rates go up or down, you will be entitled to the rate of interest that was committed to you.
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FDs pay a higher rate of interest than your savings bank account. The current rates, as of early April, for a one-year FD are approximately 8-8.5%. Your savings bank account offers you only 3.5% interest.
Other conditions being equal, you are better off putting your money in an FD account rather than a savings account. The interest can be paid to you quarterly, half-yearly or annually. If you are a senior citizen, the interest rate on your FD may go up by 0.5%.
1. Bank and NBFC FDs: Offered by banks or non-banking finance companies; the Reserve Bank of India (RBI) regulates these institutions.
2. Corporate FDs: These are offered by companies that are looking to raise money from the open market. Corporate FDs typically pay a higher rate of interest, but also carry a relatively higher risk than bank FDs.
• FDs offer a safe return: FDs are usually secure and are very low-risk investments. Bank FDs are guaranteed up to Rs1 lakh by the Deposit Insurance and Credit Guarantee Corporation.
• You can raise a loan against your FD: You can borrow up to 85% of your deposit amount (in some cases, only after a few months of your FD’s existence). This is valid only for bank FDs.
• Low maintenance: Unlike other investments such as stocks, mutual funds or even real estate, you don’t need to monitor your FDs on a daily or monthly basis, or undertake any kind of maintenance work.
• Choice of time period: You can make a deposit for any period of time, from 15 days to 10 years.
• Relatively low returns: Because FDs are very low-risk instruments, they offer low returns compared with alternative investment options such as stocks and mutual funds.
• Lock-ups: Your money will be locked up in an FD for the duration of the deposit. As a result, unlike a savings bank deposit, you will lose the flexibility of accessing your funds whenever needed. You can break your FD if needed, but you would have to pay a penalty, which could include both a reduced interest rate as well as charges that are typically around 1%of the investment amount.
• Unfavourable tax treatment: Unlike other investment options, interest income earned from FDs will be added to your income and taxed.
Taxes and FDs
• Tax-saving investments: Under section 80C, you can get a tax deduction of up to Rs1 lakh a year if you invest in a five-year FD.
• FDs and tax deduction at source (TDS): If the aggregate interest income that you are likely to earn from all your bank FDs held in a single branch is at least Rs10,000 in a financial year (Rs5,000 in the case of corporate FDs) then TDS will be deducted at 10%.
• If you do not fall in a taxable slab, then furnish Form 15G or 15H to your bank to prevent TDS on the interest income that is paid to you.
7 things to watch out for
1. Always appoint a nominee on your FD for quick withdrawals, and to avoid hassles if you are not around.
2. FDs from companies might pay more but come at a much higher risk than bank FDs. These FDs are not deposit-guaranteed.
3. In times of rising inflation, avoid FDs because your money will lose its purchasing power.
4. When making a deposit, check the penalty clause for early withdrawal.
5. If you need to withdraw funds for an emergency, instead of breaking the FD, you might want to consider taking an overdraft of up to 85% on your FD rather than pay the withdrawal penalty.
6. You might want to split your investment and make multiple deposits in small sizes and spread them across different maturities as opposed to making a single large deposit. This way, even if you do have to make a premature withdrawal, you will not pay a penalty on the entire amount but just on the limited amount you withdraw.
7. For FDs longer than a year, if your interest is paid at maturity, the taxes on interest income from your FDs are due on interest earned, even if the interest hasn’t been received by you.
(Kartik Varma and Dhruv Agarwala graduated from Harvard Business School and are co-founders of the New Delhi-based iTrust Financial Advisors)
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