The dual features of income certainty and capital protection make bank fixed deposits (FDs) one of the most preferred investment instruments for new and conservative investors. But lack of adequate product awareness regarding FDs often stop depositors from realising maximum benefits from their bank FDs.
Here I will explain some crucial facets of bank FDs that investors need to be aware of:
1. Deposits up to Rs 5 lakh with each scheduled bank are covered under deposit insurance
The Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of RBI, offers deposit insurance cover for deposits opened with scheduled banks. The insurance program covers cumulative bank deposits, which include fixed deposits, savings account, recurring deposits and current account, of up to Rs 5 lakh per bank per depositor in case of bank failures. Both the interest and principal component of bank FDs are covered under this program.
As the Rs 5 lakh cover applies separately to the deposits held in each scheduled bank, risk-averse investors can benefit from high-yield fixed deposits while ensuring maximum capital protection by distributing their FDs across multiple banks in such a manner that their cumulative deposits with each bank do not exceed Rs 5 lakh mark.
2. Penalty on premature withdrawals lowers your earning
Most depositors select their FD tenure on the basis of the highest interest rate available, without factoring liquidity and investment horizons. Unforeseen emergencies or over-looked financial goals can propel them to withdraw FDs prematurely and thereby, incur premature withdrawal penalty of up to 1%. The penal rate is deducted from the effective rate of interest, which is generally the lower of original card rate and FD card rate for the period the deposit has been into effect. Hence, ensure to factor in liquidity and investment horizon of your financial goals to avoid incurring premature withdrawal penalty and loss of interest income.
3. Depositor’s tax liability doesn’t end with TDS
Tax liability of FD investors does not end with the deduction of TDS by banks. The interest income on your FD is taxable as per the tax slab of the depositor, except for tax deduction of up to Rs 50,000 available to senior citizens under Section 80TTB. The difference between actual tax liability and TDS amount deducted gets adjusted at the time of filing income tax returns. Hence, always factor in tax slab while calculating post-tax return from FDs. Doing so will help make better comparison between the post-tax interest income generated by fixed deposits and post-tax returns from fixed income alternatives like debt mutual funds.
4. Interest income from tax-saving FD is not tax-free
Tax-saving bank FDs of up to Rs 1.5 lakh per financial year qualify for tax deductions under Section 80C. These tax-saving FDs come with a lock-in period of 5 years. However, just like non-tax saving FDs, the interest income from tax-saving FDs are also taxed according to the tax slab of the depositor.
The post-tax returns from tax-saving FDs may not beat inflation during low interest rate regimes. Hence, investors looking for higher post-tax returns from their fixed income tax saving instruments should prefer small savings schemes offering tax-free returns.
Those with higher risk appetite can opt for Equity Linked Saving Schemes (ELSS). These tax-saving mutual funds are more tax-efficient as only the capital gains booked beyond Rs 1 lakh in a financial year attract LTCG (Long Term Capital Gains) tax @ 10% irrespective of your tax-slab. These tax saving mutual funds also offer one the lowest lock-in period of just 3 years among all Section 80C options. Their long-term returns also outperform FD returns by a wide margin over the long term.
5. FDs can be leverage to avail secured cards
FD investors having nil or low credit score can leverage it to avail secured credit cards. As the transactions made through secured cards are reported to the credit bureaus, disciplined usage of secured credit cards can help in building or improving one’s credit score. Such cards can also be helpful for those who fail to avail regular credit cards due to other reasons like inadequate income, unserviceable location, employer’s profile or job profile.
6. Availability of loan against FD to meet cash flow mismatches
Most banks offer loans against fixed deposits, usually in the form of overdraft facility. A credit limit is sanctioned to the borrower based on the FD amount pledged as collateral and interest is levied only on the amount drawn till its repayment. However, the borrower continues to earn interest on the pledged FDs during the loan tenure. Borrowers can withdraw up to the sanctioned amount from their overdraft account and repay it as per their repayment capacity.
These features of a loan against FDs make them an excellent tool for mitigating frequent liquidity and cash flow mismatches, without requiring premature closing of FDs and incurring premature withdrawal penalties.
(The author is Director, Paisabazaar.com)