Everything you need to know about FDsIs it better to lock your money in a fixed deposit account or use it in other investment options? We help you make the right decision

 

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.

Raajan / Mint

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%.

Two types

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.

Advantages

• 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.

Disadvantages

• 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)

CONNECT  

When buying a house, don’t ignore hidden costs such as

the money required to get the property registered in

your name, additional charges the builder might levy

for preferred location, club membership, parking and

sundry expenses.

Calculate the full cost of buying a house by including all these expenses in

addition to the basic sales price of the property. These expenses will also be

an outflow of cash and you must not be thrown off by them so much that you

can’t afford your dream house.

DO  

If you are single and have no financial dependants, then

avoid taking life insurance because you do not need it.

Life insurance is necessary if you have financial

dependants, such as a spouse, children or parents, whose

life would be materially affected if you are not around to

provide for their financial needs. In the absence of any

financial dependants, you are better off using your money for some other

financial instrument or buying personal accident cover or disability

insurance, in case you get into an accident and are unable to work for an

extended period of time.