16 facts about Fixed Deposits you must know…

16 facts about Fixed Deposits you must know…

The fixed deposit party is back. Roadside hoardings and news paper advertisements announcing double digit interest rates on fixed deposits are back in vogue.

With stock markets staying volatile, thousands of investors are flocking to the safety and returns provided by fixed deposits. If you are planning to open a fixed deposit to park your savings, here are 16 things you should keep in mind before signing on the dotted line.

Fact 1. It is not just the bank, even companies offer fixed deposits

Interest rates offered on deposits by companies are usually higher (by 2 to 6% or more) than rates offered by the banks.

Company deposits are governed by the rules under Section 58A of the Companies act. As per the current prevailing regulations a manufacturing company can offer fixed deposits having duration from 6 months to 3 years,  non-banking finance companies: 1year to 5 years, housing finance companies: 1 year to 7 years.

Fact 2. Bank fixed deposits are secured, company fixed deposits are not

This is the crucial difference between fixed deposits offered by banks and companies. Bank deposits are secured by Deposit Insurance and Credit Guarantee Corporation (DICGC) upto a maximum of Rs. 1 lakh per account. In case of bank failure, DICGC protects your deposits upto a limit of Rs. 1,00,000 held in any nationalized or private sector bank or co-operative bank in India.

There exists a general misconception among masses that every FD or savings account is separately insured by DICGC. This is not true. All your funds lying in savings accounts, all fixed and recurring deposits across all branches of a bank are accounted together for the insurance guarantee. In case you have a balance exceeding 1 lakh with your current bank, then you do not benefit in any way from this insurance cover when you open a new FD account with the same bank.

Some people advise spreading money across various banks to keep account balances under 1 lakh with each bank to benefit from the DICGC insurance. We believe this is an advice only for the paranoid. As long as you are dealing with good banks and staying away from small co-operative banks, you have nothing to worry.

Fact 3. Stay away from companies offering very high interest rates on fixed deposits

This seems to be counter intuitive advice. After all higher interest rates are good, right? Wrong!

Ask yourself why companies are offering such high interest rates and you will get the answer.

Banks have been the traditional lenders of choice for everyone, corporates included. But banks are very good in judging the risk profile of their loan applicants. They do a lot of diligence before sanctioning loans to companies. If they sense any problem with the business or the financial strength of the company, they either outright deny the loan or lend at higher than normal interest rates. In such situations companies usually turn to common public to collect funds. They lure retail investors by offering higher than bank rates (but lower than what banks would charge them for a loan) on their fixed deposits. It’s a win-win situation for both. The retail investor gets above bank rates for the extra risk she is taking, while the company can raise funds at rates lower than what the banks would have charged them.

If a company is offering abnormally high rates on their FD’s, it’s a sign that something is wrong. Either the banks are not lending to the company or lending at very high rates or the perception of the company with general public is not so good that they are compelled to offer very high rates to lure retail investors. Either way it’s a red sign to stay away. And remember, there is no deposit insurance in-case the company goes belly up or simply refuses to payback your principal.

Fact 4. Higher interest frequency need not necessarily mean higher returns!

You must be thinking that this is bizarre, higher compounding frequency means higher annualized rate of return, right? True, but as they say – devil lies in the details.

Banks generally offer quarterly compounding rates on fixed deposits. The absolute annual yield on such deposits works out to more than the compounding rates. The higher the compounding frequency, higher will be the annualized yield.

During periods of high interest rates, banks sometimes come out with deposits where the interest is credited on a monthly basis. If you read the fine points, you will find that such products the interest is “paid-out”, not compounded! This means the interest is paid out to your savings account and not accumulated in the FD account where it can undergo compounding.

Sorter term deposits (less than 6 months or a year) generally pay simple interest for the term of the deposit without compounding.

Learn to observe these little details and you will not be disappointed later.

Fact 5. Senior citizens get higher interest rates

This is an old practice followed by many banks and you are probably aware of this. The rates offered are generally in the range of 0.25 to 0.75% higher than normal rates and available only to people above 65 years of age.

This is a practice generally followed by banks and some companies and is not a rule.

Fact 6. You need not be a senor citizen to enjoy (higher) senior citizen rates!

Here’s the trick. Convince your grandparent or parent (if senior citizen) to become a joint applicant in your FD. Ensure that the first applicant is a senior citizen (your grandparent/parent) and your fixed deposit application will be eligible for higher senior citizen rates.

The eligibility for senior citizen rate is determined solely by the age of the first applicant in a joint application. Talk to your relationship manager before your make the application to avoid any unnecessary confusion later.

Fact 7. Your deposits will earn lower than promised returns if you withdraw prematurely

We are not talking about the penalty here (that’s the next point), but the actual rate of interest earned by your FD account. This is how the calculation works:

Consider a situation where your bank is providing 9% for a 1-year term and 10% for a 2-year term deposit. Suppose you open an FD for a term of 2 years, and after 1 year you are in urgent need of cash and decide to break this FD. The bank will not offer you 10% on the deposit you maintained for a year. Instead it will offer you the prevailing rate of interest for a 1-year deposit at the time you opened your fixed deposit account. Since the rate for a 1 year term deposit at the time of booking the FD was 9%, your FD will earn 9% interest on the principal instead of the originally promised 10%. So you potentially lose 1% interest, and also pay a penalty (usually 1%, could be less for some banks) for pre-closure. Your effective return falls to approximately 8% from the initial 10% after taking into consideration the prevailing 1 year rate and penalty.

This is true for fixed deposit accounts maintained with banks. It’s a whole different ball game when you want to prematurely break your company fixed deposit. Companies generally do not play nice when you approach them to prematurely close your FD. In-fact, company FD’s usually have a mandatory lock-in clause of 6 months. Even if your FD is past the lock-in period, be prepared to run pillar to post if you want to collect your principal before the end of the scheduled term. The actual rate you will be offered will be at the company’s discretion and may not be as transparent as with the banks.

Fact 8. Penalty on premature withdrawals can be negotiated

This is something not many people know. Although the rule book says that the bank can charge you a fixed penalty (usually 1%) on the balance amount in case of premature withdrawal, the final decision rests with the branch manager. If you are withdrawing to take benefit of higher rates, and intend to open a new FD at the same branch, more often than not, the manager will waive the penalty.

All you need to do is ask politely.

Fact 9. Interest on fixed deposits are taxed before it is paid out to you

Interest earned on fixed deposit is treated as “Income from other sources” for the purpose of taxation. However banks and companies are required to deduct a nominal 10% tax at source (TDS), plus 3% education cess on tax (in total 10.3%) before crediting the interest amount to you. With effect from 1^st April 2010 this rate is increased to 20% for individuals who fail to furnish PAN proof. So make sure your bank has your PAN details, else you will be taxed at a higher rate.

As per the prevailing laws, banks are required to deduct TDS once the interest amount (earned on all your accounts with the bank) exceeds Rs.10,000. For company deposits, the limit is Rs. 5,000 after which TDS is deducted on the entire interest earned.

This (TDS) is the reason why the final amount credited back to you on completion of the fixed deposit term is always less than what you had originally guesstimated.

Fact 10. Not all 5 year fixed deposits enjoy section 80C income tax exemption

Section 80C of income tax law currently allows exemption on amount invested in certain 5 year fixed deposits. The exemption is available for the entire amount invested in such deposits upto a maximum limit of 1 lakh.

Such fixed deposits have a fixed tenure of 5 years. Only banks can offer such deposits and 5 year company deposits do not enjoy this exemption. Besides not all 5 year bank deposits enjoy this benefit. The deposit certificate issued by the bank against such FD account should clearly mention that the deposit is collected as per the terms of section 80C. Such deposits cannot be withdrawn or pledged before completion of the full 5 year term. The interest is taxed just like any other fixed deposit.

Fact 11. Interest earned on FD’s in the name of minors having no other income is also taxable

Minors cannot legally get into any financial transaction independently. All such transactions are to be handled by the parent or legal guardian. Taxation is no different. Interest earned by the minor on his/her FD is to be clubbed with the guardians’ income for income tax purposes (there are some exceptions to this rule).

Fact 12. You can avoid TDS if you do the necessary documentation

The documentation we are referring to is Form 15G and Form 15H.

Senior citizens with income under the basic tax limit (currently Rs. 2,40,000) need to furnish Form 15H to be exempted from TDS. Individuals below 65 years whose income is less than the taxable limit need to furnish Form 15G to be exempted from TDS.

The documents have to be submitted to the bank/company before the first interest payment. If you fail to furnish these details, you can still reclaim your money by filing income tax returns and claiming the refund on excess tax collected.

Fact 13. You need to declare the interest earned on your FD’s in your annual income tax returns

Interest earned from fixed deposits will be added to your total income and taxed at marginal rates depending on prevailing tax slabs. Not many people are aware (or deliberately unaware) that they need to declare their interest income from FD’s and savings accounts in the annual tax returns statement.

Banks furnish details related to interest credited and taxes deducted for all the PAN holders to the IT Department. You can view these details in your Form 26AS statement by logging on to IT Department’s website. It’s been roughly three years since IT Department has been completely computerized, and it is just a matter of time before they decide to send notices and fine all those who have under-reported their interest income.

Fact 14. You can get a loan or overdraft facility against FD

Your FD can be a security for loan or an overdraft facility. Such loans will be offered at lower than standard rates and limited to a percentage (70 to 90%) of your FD amount. Such facilities are provided on the condition that the bank can withdraw money from your FD account without your consent, in case you default on your payments.

Fact 15. Some banks offer secured credit cards against your FD

Just like loan against FD, banks also offer credit cards secured by the amount in your FD account. The monthly interest rates are usually less than 2% as compared to 3% or more charged on normal cards. The credit limit on such cards will not be more than the the principal amount invested in the linked FD and the validity period coincides with the maturity date of the term deposit. The only real benefit of a secured card (apart from the low interest rate) is the reduced processing time when compared to normal credit card application process.

Fact 16. Sweep-In fixed deposits
Some banks have started introducing a new system of sweeping-in excess cash from savings accounts into Fixed Deposits. Under this system excess funds in your savings account will be moved to new Fixed Deposits of predetermined tenure. Thanks to computerization, your money is stored as bits and bytes on the banks servers which makes features like these heretofore unthinkable, possible.

The swept-in deposits are eternally linked to your savings account and pay interest directly into your savings account. This allows you to benefit from higher fixed deposit rates on your cash idling in your savings account earning mere 3.5% p.a. In case the account balance in your savings account were to fall below a predetermined threshold, the linked fixed deposit(s) is liquidated to replenish the shortfall (sweep-out). All this happens automatically behind the scenes without requiring any manual intervention. The threshold limits, minimum balance requirements, terms and conditions and charges if any for such a system vary from bank to bank, hence consult your relationship manager before signing up for a sweep-in savings account.

If you know of any other points which we have missed to mention, please share such details in the comments section.