If you’re beginning your work life and want to start saving money for your future needs, the best way to get started is to make a deposit at your bank.
The money in the deposit earns a higher interest rate than a savings account. This allows you to put away money for needs such as creating an emergency fund or fulfilling an aspiration such as travel.
Deposits are easy to open. You can do it through your bank app or by visiting the branch. They are also easy to liquidate. The money in the deposit grows at a low rate, thus allowing you to earn interest.
But beginners may want to know how these deposits work. Primarily, there are two kinds of deposits to be availed: fixed deposits (FDs) and recurring deposits (RDs).
If you must choose between FDs and RDs, which one would you go for? These are non-market linked fixed return financial instruments. If you want to decide, you should match features and check which one fits well with your financial goals. Let us make this comparison simple for you to choose according to your requirements.
What Is A Fixed Deposit?
Fixed deposits are savings instruments that provide interest at a fixed rate for the term the money is deposited. When the term completes, the deposit matures and is returned to you. You can have cumulative or non-cumulative FDs. In cumulative interest FDs, you get the principal and compounded interest on maturity. In non-cumulative FDs, you will have the option of receiving interest on a regular interval, i.e., monthly, quarterly, etc.
Typically, investors who are young and have other sources of income prefer cumulative FD. Senior citizens or retirees who want a regular income prefer non-cumulative FDs to earn regular interest for their income needs.
Interest earned on FDs is fully taxable in the hand of a non-senior citizen taxpayer. Interest income is added to the total income and taxed per the applicable slab rate. It is important to mention that if interest income during a financial year is above Rs 40,000, it is subject to Tax Deduction at Source (TDS) by the bank. The threshold for senior citizens is Rs 50,000. Under Section 80TTB of the I-T Act, interest income up to Rs 50,000 on bank deposits during a financial year is tax-free for senior citizens.
Let’s understand TDS on FDs a little better with an example.
Suppose you (a non-senior citizen) deposited Rs 10 lakh at an interest of 7% for a 5-year tenure. The maturity amount after TDS would be Rs 13.68 lakh. The bank deducts a TDS of Rs 40888 in 5 years. The depositor can’t benefit from compounding on the amount that the bank deducts as TDS. TDS is deducted in case of company deposits if interest income exceeds Rs 5000 in a financial year.
FDs should be your savings instrument if you have a lump sum in hand and are exploring avenues to park them to earn a return with low risk. You can park the money in large banks which offer high safety and moderate returns. You could also go for smaller banks which offer higher rates but are considered less safe. When banking with a bank considered less safe, don’t deposit more than Rs 5 lakh, because that is the money you may be able to recover from a deposit insurance claim, should that bank fail and get liquidated.
What Is A Recurring Deposit?
Recurring deposits are fixed interest and fixed tenure monthly savings instruments. Like FDs, RDs also give you the same interest for the entire tenure, which is agreed upon at the start of the tenure. However, unlike FDs, RDs allow a depositor to save in instalments, i.e., a fixed amount is deducted every month from your bank account.
There is no tax-saving RD product, but in FDs, you have the option of a five-year tax-saving FD if you want to save taxes under Section 80C. In RDs, most banks allow interest on the maturity of the deposit whereas in FDs, you get the choice of interest on regular intervals. RDs are suitable for risk-averse investors looking to build a corpus by saving in instalments over a period of time.
FDs are lump sum investments. Therefore, they allow you greater interest return than RD. Here’s an illustration table showing the difference in interest returns between FD and RD.
Choose What Suits You
The choice of FD vs. RD solely depends on how much fund is available to you at the investment time. If you have a hefty fund to invest in for a definite tenure, you may choose FD as they can offer you greater compounding benefits. However, if you are expecting a fixed monthly saving from your income in the future, you may deploy that saving into RDs to earn a higher return. Both FD and RD are almost the same in terms of tax applicability. It will be advisable to take a decision on your financial goals while choosing between FD and RD.
(The author is CEO, Bankbazaar.com)