Cumulative vs non-cumulative FD — Which is better for retirees? Know which suits you

Fixed deposits are considered one of the safest investment options for conservative investors who are seeking stable and predictable returns. Unlike market-linked instruments such as stocks and mutual funds, FDs offer a fixed rate of interest for a predetermined tenure.

There are two types of FDs, cumulative and non-cumulative, which are classified based on how the interest payout is done. Here's how they differ:

• Cumulative FD: The interest earned is reinvested and paid along with the principle upon maturity, helping investors benefit from compounding.
• Non-cumulative FD: The interest is paid out at regular intervals such as monthly, quarterly, half-yearly, or annually, giving you a regular stream of income.

Among major lenders in India, including HDFC Bank, the States Bank of India (SBI), ICICI Bank, and Axis Bank, fixed deposit interest rates generally range between 6 and 7.25% annually, with senior citizens typically receiving an additional 0.5% on investments. Meanwhile, many small finance banks tend to offer comparatively higher FD interest rates. However, the nominal interest rate offered usually remains the same for both cumulative and non-cumulative FDs.

You should also note that once your open a FD, the interest rate remains the same throughout the tenure, whether it is 3 years, 5 years or even 10 years. Any future changes in FD interest rates by banks will not be applicable on an active FD.

Who should invest in a cumulative FD?

A cumulative FD is ideal for those who do not rely on regular interest income for their day-today expenses. It is best suited for salaried individuals, business owners, or long-term savers looking to build wealth gradually through compounding.

In this case, the interest is reinvested instead of being paid out regularly. Thus, the interest accrued in the first cycle (generally yearly or quarterly) is added to the principal, leading to an increased principal. Interest in the second cycle is calculated on this increased principal that leads to higher interest. This continues until the FD tenure is not over.

If you are investing with a specified financial goal in mind, such as funding higher education, buying a house, building an emergency corpus, or planning for retirement, a cumulative fixed deposit can be a suitable option. For retirees, this may be a suitable option only if they start their savings early to let the corpus grow and then withdraw it.

For example: If you invest ₹50 lakh in a FD and earn an average return of 7% per annum with quarterly compounding over 10 years, the investment would grow to nearly ₹1 crore. After maturity, you can either withdraw the money or reinvest the proceeds into a new FD to continue compounding and build a larger corpus.

Reinvesting can also work in the your favour if FD interest rates rise over time. Since every renewed FD is booked at the prevailing interest rate, investors may benefit from higher returns in such a case.

If investors wish to save a fixed amount each month instead of making a lump-sum investment, they can also consider opening a recurring deposit account (RD), which allows individuals to deposit a predetermined amount monthly for a fixed tenure while earning assured returns.

Who should invest in non-cumulative FD?

A non-cumulative FD is suitable for those who who prefer a steady and predictable income from their investments instead of waiting until maturity for the entire payout.

It may work well for retirees who rely on interest earnings to meet monthly household expenses after leaving the workforce. Considering they won't have an active source of income, FDs can provide some passive income, but the payout's value depends on how much you have invested.

Based on some prevailing FD interest rates, here is an estimate of how much investment may be required to generate a monthly income of ₹10,000 through interest payouts:

• 6% interest rate: The investor would need to invest around ₹20 lakh in an FD to generate ₹10,000 every month.
• 7% interest rate: The required investment comes down to nearly ₹17.14 lakh.
• 7.25% interest rate: An investor would need to put around ₹16.55 lakh in a fixed deposit.
• 7.5% interest rate: An investment of around ₹16 lakh would be needed.
• 8% interest rate: The required investment reduces further to about ₹15 lakh.

Since the investor wants ₹10,000 every month as payout income, the interest is assumed to be withdrawn regularly instead of being compounded. However the principle amount remains intact and can be withdrawn as per your wish.

How taxation differs for cumulative vs non-cumulative FDs?

Taxation on fixed deposits is largely the same for both cumulative and non-cumulative FDs, as the interest earned is taxable under the head “Income from Other Sources.” However, the timing of interest payout creates a difference.

For a cumulative FD, you can choose to pay the tax in any of the following two ways:

• Accrual basis: An investor has to report interest that is credited or becomes due for the year, even if they have not withdrawn it yet.
• Receipt (cash) basis: In this case, you have to report interest in the year when you actually receive it, either during periodic withdrawal or when the FD matures.

In a non-cumulative FD, the interest is paid out periodically, and the interest received during the year is taxed accordingly in that financial year itself.

Banks also deduct Tax Deducted at Source (TDS) on FD interest. It is deducted at 10% if yearly interest exceeds ₹50,000 for regular individuals who have a PAN, and if you don't have one, then higher rate will be applicable. The same rule applies for senior citizens if their interest income exceeds ₹1,00,000 in a year.