Money managers who deal with stock market investments always ridicule a bank FD. Yet, there is a class of investors who remain loyal to this asset class, given the safety and liquidity it offers.
WHY IS A FD NOT CONSIDERED GOOD ENOUGH?
The common criticism is that the returns on a FD do not beat inflation.
Interest earned is taxable beyond a limit of Rs.40,000/- p.a. Subtract the tax payable from return on investment, and you have a figure less than the prevailing inflation rate.
So, your money gets devalued over a period of time.
Exact numbers will depend on the tax rate applicable to you.
And there are exceptions to this generalized theory.
WHY DO INVESTORS PREFER FIXED DEPOSITS?
1. Safety of principal
Public sector banks are supported by the government, and not likely to fail. Large private sector banks have merged with other banks, moved to the public sector, but have not failed to pay back client deposits.
Risk-averse investors don’t want to risk the principal amount invested, which can happen in market-related instruments.
2. Operational convenience
Almost the entire financially literate population has a bank account. One can book a FD by filling up a form in the bank, or through internet banking.
3. Quick redemption in case of need
A FD is a contract between the bank and investor for a specified period. However, in case of need, one can get back funds through withdrawal before maturity or a demand loan against fixed deposit.
Flexi-deposits offer the benefit of partial withdrawal without any documentation or applications.
WHY IS A FD ATTRACTIVE AGAIN?
The Reserve Bank of India has flagged the trend of rising interest rates with the recent hike of 0.4% in Repo Rate. Experts suggest that two more hikes of 0.5%, coming to a total of 1% are expected in the next two months.
Banks offer a maximum rate of 6% on fixed deposits in the current scenario. We can expect this to move up to 7% or 7.5%.
The effective yield on long-term deposits is higher than the card rate with quarterly compounding. For example, a fixed deposit placed for 1 year at the rate of 7% on compound interest, actually earns 7.16%.
The safe debt instruments that offer higher returns than this are small savings schemes offered by Post Office. However, the investments are not liquid and there is a cap on maximum amount to be invested in a single name.
If you have exhausted this limit to create a corpus for long-term financial goals, you can look at bank fixed deposits as the next option.
HOW ARE FIXED DEPOSITS TAXED?
You will pay income tax at the slab rate applicable to you, if the interest earned in a financial year is more than Rs.40,000/-.
It means an investment up to Rs.5,70,000/- in a financial year @ 7% p.a. is exempt from taxes. At an interest rate of 7.5%, the safe amount whittles down to Rs. 5,25,000/-.
Senior citizens are exempted from tax, if the interest earned is less than Rs. 50,000/- p.a. They also earn an additional interest of 0.5% above card rates.
They can invest Rs.625,000/- p.a. @8% rate of interest, or Rs.670,000/- @7.5% p.a.
Banks deduct TDS @10% p.a. if the total interest amount exceeds Rs.40,000/- or Rs.50,000/- in a year, for general category and senior citizens respectively. They will deduct 20% if the depositor fails to submit PAN details.
If you are not liable to income tax, submit Form 15G or 15H as applicable at the beginning of the financial year, or while opening a fixed deposit account. If you fail to do so, the bank will deduct TDS, but the same can be claimed as refund when you file income tax returns.
The amount of taxable interest includes interest on both savings and term deposits, so modify calculations accordingly.
WHICH FIXED DEPOSITS ARE TAX FREE?
Banks offer tax-free fixed deposits at attractive interest rates, but the amount is blocked for 5 years. The investor cannot withdraw it before maturity.
ARE FIXED DEPOSITS LIQUID ASSETS?
A term deposit is a contract between the bank and client that the rate of interest, time period and amount of deposit will remain fixed.
The bank will apply penal charges on withdrawal before maturity, to compensate for contravention of the contract.
1. Fixed Deposit Withdrawal before Maturity
In general, penal charges on premature withdrawal are 1%. Effectively, it means that the bank deducts 1% from rate of interest applicable to the period for which money has remained with the bank.
Say a FD of Rs.100,000 for I year running @7% p.a. is withdrawn after 6 months. The rate of interest applicable to a deposit for 6 months on the start date of FD is 6.5% p.a. The bank will pay interest @5.5% p.a. after applying a penalty of 1%.
2. Demand Loan or Overdraft against FDs
You have an option of availing a demand loan or overdraft against fixed deposit. The bank gives you 75% of the principal amount as loan, and charges an interest rate 2% higher than the contracted rate on the fixed deposit.
The loan available for a FD of Rs.100,000/- running @7% p.a. will be Rs.75000/- @9% p.a.
3.Flexi-deposits or Liquid Deposits
This is a combo product of savings and fixed deposit account.
Any surplus amount in the savings account beyond a specified minimum goes to a FD account, at the end of every working day. In case of need, you can withdraw the amount in parts from the fixed deposit account.
Terms and conditions are applicable. The minimum amount for a FD is Rs.5000/- and the minimum period is 7 days. Retail card rates are applicable and transactions are done only in round figures. The bank may apply the principle of First In, First Out (FIFO) or Last In, First Out (LIFO) for withdrawal, as per policy.
ARE MY FIXED DEPOSITS SAFE?
Recent bank failures have raised fear and suspicion in the mind of fixed deposit holders and rightly so.
Deposits up to Rs. 5 lakhs in a single holding pattern are insured by Deposit Insurance and Credit Guarantee Corporation, if the bank subscribes to DICGC cover.
You can spread your money in different banks in different holding patterns to avail of this protection. Do check if the bank is subscribed to the DICGC scheme.
Different holding patterns means that a family of three members A, B and C can open single or joint accounts in patterns A, B, C, AB, AC, BC, BA, CA and CB.
DICGC cover does not extend to non-banking finance companies. Hence, one needs to exercise care despite the lure of higher interest rates.
This is a concept which provides some protection against the vagaries of fluctuating interest rates. You need not block the entire amount for a long period.
Split the amount available for investment, say in 3 parts, and invest for 1,2 and 3 years.
At the end of every year, one FD will mature offering an option for re-investment with better returns.
Happy banking on a safe future 😊
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