Bank fixed deposits are one of the most preferred financial instruments especially for new and conservative investors due to its income certainty and capital protection. However, lack of adequate product knowledge often stop depositors from gaining optimum benefits from their bank FDs. Here are some of the crucial aspects of bank fixed deposits that every depositor should be aware of:
Banks charge premature withdrawal penalty on breaking the FD before their maturity dates
Many depositors choose their FD tenures based on the FD interest rates. But liquidity and investment horizons are the two important parameters that should be taken into consideration before opening a fixed deposit. Overlooked financial goals or financial emergencies may cause them to liquidate their FDs, partially or fully, and thereby in the process, incur premature withdrawal penalty. The penal rate for premature FD withdrawal is deducted from the effective interest rate of the FD, which is generally the lower of its original card rate and the card rate for the duration the deposit amount has been in effect. This leads to loss of interest income for the depositors.
Those having frequent cash flow mismatches can opt for sweep-in facility wherein a savings/current account is linked to a fixed deposit account. When the balance in the savings account goes beyond the specified limit, the balance amount is transferred to the linked FD account. Similarly, when the balance of the linked savings account falls below the pre-specified threshold, the shortfall amount will be transferred from the fixed deposit account to the savings account. Depositors can use this facility to ensure liquidity while earning higher interest than the savings account.
Interest income of FDs are also taxable
The tax liability of the fixed depositors does not end with the TDS deduction made by the banks. The interest income of fixed deposit (including tax saving FDs) is also taxable as per the tax slab of the depositor (except for senior citizens eligible for tax deduction of up to Rs 50,000 under Section 80TTB) whereas the TDS rate is 10% (20% when PAN details are not provided).
The difference between the TDS amount and accrued tax liability is adjusted while filing IT returns. Hence, depositors should always consider their tax slab while calculating their post-tax return from their fixed deposits. This will help depositors make a better comparison between the post-tax interest income from their fixed deposits and the post-tax returns from corporate bonds, debt mutual funds and other fixed income alternatives.
Interest income from tax-saving FD is taxable
Tax Saver FDs come with a lock in period of 5 years and only the principal amount of up to Rs 1.5 lakh in a financial year is allowed for tax deduction under Section 80C. Just like non-tax saving FDs, the interest income from tax-saving fixed deposits are taxed as per the income tax slab of the depositor. Therefore, the post-tax returns from tax-saving FDs rarely beat inflation rates. Hence, investors looking for higher post-tax returns from their fixed income tax saving instruments should choose small savings schemes offering tax-free returns. However, consumers should factor in the lock-in periods of those small savings schemes. Those having higher risk appetite can also opt for other fixed income instruments like debt-oriented mutual funds, government/corporate bonds, etc.
DICGC covers deposits of up to Rs 5 lakh with each scheduled bank
The Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of RBI, insures cumulative bank deposits, which include recurring deposits, savings account, fixed deposits and current account, of up to Rs 5 lakh per bank and per depositor for both principal and interest amount.
This insurance cover provided by the DICGC applies separately to the deposits held in each scheduled bank. Thus, risk-averse investors can distribute their FDs across various banks in such a manner that deposits do not exceed Rs 5 lakh with each scheduled bank. Doing so will help investors benefit from high yield fixed deposits while ensuring maximum capital protection.
You can leverage your FDs to manage your cash flow mismatches
Depositors can manage their cash flow mismatches by opting for a loan against facility offered by most banks, usually in the form of overdraft. In this case, depositors did not have to liquidate investments or break FDs incurring premature withdrawal penalties. The credit limit is sanctioned based on the FD amount pledged with the respective bank as collateral. The interest is levied only on the amount drawn until the borrower repays it as per his repayment capacity. However, the FD pledged as collateral continues to earn interest during the loan tenure.
Your FDs can help you to improve/build credit score
Banks issue secured credit cards wherein their FDs are used as collateral. Just like regular credit cards, the transactions made through secured credit cards are reported to the credit bureaus. Secured credit cards also come with reward point programs, discounts, cashbacks and other offers. Thus, depositors who are new to credit or those who cannot avail regular credit cards due to their location, lack of income, low credit score, etc can avail secured credit cards and thereby, build/improve their credit score through disciplined usage of such secured cards. Improved credit scores would then increase their chances of availing regular/premium credit cards and loans, at possibly lower interest rates.