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Everything you need to knowabout FDs

Is it better to lock your money in a fixed deposit account or use it inother 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 thecourse of the FD, even if the prevailing interest rates go up or down, you willbe entitled to the rate of interest that was committed to you.Raajan / MintFDs pay a higher rate of interest than your savingsbank account. The currentrates, as of early April, for aone-year FD are approximately8-8.5%. Your savings bankaccount offers you only 3.5%interest.Other conditions being equal,you are better off putting yourmoney in an FD account ratherthan a savings account. Theinterest can be paid to you quarterly, half-yearly or annually. If you are asenior citizen, the interest rate on your FD may go up by 0.5%.

Two types1. Bank and NBFC FDs:

Offered by banks or non-banking financecompanies; the Reserve Bank of India (RBI) regulates these institutions.

2. Corporate FDs:

These are offered by companies that are looking to raisemoney 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-riskinvestments. Bank FDs are guaranteed up to Rs1 lakh by the DepositInsurance 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’sexistence). This is valid only for bank FDs.

• Low maintenance:

Unlike other investments such as stocks, mutualfunds or even real estate, you don’t need to monitor your FDs on a daily ormonthly 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, theyoffer low returns compared with alternative investment options such asstocks and mutual funds.

• Lock-ups:

Your money will be locked up in an FD for the duration of thedeposit. As a result, unlike a savings bank deposit, you will lose the flexibilityof 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 reducedinterest rate as well as charges that are typically around 1%of theinvestment amount.

• Unfavourable tax treatment:

Unlike other investment options, interestincome earned from FDs will be added to your income and taxed.

Taxes and FDs• Tax-saving investments:

Under section 80C, you can get a taxdeduction 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 interestincome 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 yourbank to prevent TDS on the interest income that is paid to you.

7 things to watch out for1.

Always appoint a nominee on your FD for quick withdrawals, and to avoidhassles if you are not around.

FDs from companies might pay more but come at a much higher risk thanbank FDs. These FDs are not deposit-guaranteed.

In times of rising inflation, avoid FDs because your money will lose itspurchasing power.

When making a deposit, check the penalty clause for early withdrawal.

If you need to withdraw funds for an emergency, instead of breaking theFD, you might want to consider taking an overdraft of up to 85% on your FDrather than pay the withdrawal penalty.

You might want to split your investment and make multiple deposits insmall sizes and spread them across different maturities as opposed tomaking a single large deposit. This way, even if you do have to make apremature withdrawal, you will not pay a penalty on the entire amount but just on the limited amount you withdraw.

For FDs longer than a year, if your interest is paid at maturity, the taxeson interest income from your FDs are due on interest earned, even if theinterest 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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