Bank FDs are one of the most popular financial instruments for new and conservative investors due to the dual benefits of income certainty and capital protection. However, a lack of product awareness often prevents depositors from realizing the optimum benefits of their bank fixed deposit.
Here are some of the fundamental aspects of bank FDs that every individual needs to be aware of:
Deposit insurance covers cumulative deposits of up to Rs 5 lakh with each scheduled bank
The Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the RBI, offers deposit insurance coverage for deposits opened with scheduled commercial banks. DICGC insures cumulative bank deposits, which include fixed deposits, recurring deposits, savings accounts, and current accounts, of up to Rs 5 lakh per bank per depositor in the event of bank failures. Both the principal and the interest component are insured under this program.
Note that the Rs 5 lakh insurance coverage applies separately to the deposits held in each scheduled bank. Thus, risk-averse investors can benefit from high-yield FDs while ensuring maximum capital protection by distributing their fixed deposits across various scheduled banks in such a way that their cumulative deposits do not exceed the Rs 5 lakh mark with each bank.
Premature withdrawals lower your earnings
Most depositors choose FD tenure solely on the basis of FD interest rates without taking into consideration their liquidity and investment horizons. Unforeseen exigencies or overlooked financial goals may cause them to prematurely withdraw their FDs and thereby, incur a premature withdrawal penalty of up to 1%. The penal rate is deducted from the effective FD interest rate, which is generally the lower of the original card rate and the fixed deposit card rate for the duration the deposit has been in effect. Hence, depositors should factor in liquidity as well as the investment horizon of their financial goals to avoid incurring a premature withdrawal penalty and thereby a loss of interest income.
TDS is not the end of the depositor’s tax liability
The tax liability of the depositors is just not limited to the TDS deduction made by banks. The interest income on an FD is also taxable according to the tax slab of the depositor, except for the tax deduction of up to Rs 50,000 available to senior citizens (aged 60 years and above) under Section 80TTB of the Income Tax Act.
The difference between the TDS amount and the actual tax liability is adjusted when filing income tax returns. Hence, depositors should always take their tax slab into consideration while calculating their post-tax return from their FDs. Doing so will help depositors make a better comparison between the post-tax interest income from their FDs and the post-tax returns from fixed income alternatives like corporate bonds and debt mutual funds.
Interest income from tax-saving FD is taxable
According to Section 80C of the Income Tax Act, tax-saving bank FDs of up to Rs 1.5 lakh in each financial year qualify for tax deductions. These tax saving FDs have 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. Therefore, the post-tax returns from tax-saving FDs rarely bear inflation rates. Hence, investors looking for higher post-tax returns from their fixed-income tax saving instruments should opt for small savings schemes offering tax-free returns.
Individuals with a higher risk tolerance can opt for Equity Linked Saving Schemes (ELSS). These tax-saving mutual funds are more tax-efficient as long-term capital gains up to Rs 1 lakh booked in a financial year are tax-free. Only the and any gains above the threshold limit attract LTCG (Long Term Capital Gains) tax @ 10% irrespective of your tax slab. These tax-saving mutual funds also offer one of the lowest lock-in period of just 3 years among all Section 80C options. Furthermore, their long-term returns outperform FD returns by a wide margin over the long term.
FDs can be leveraged to avail secured cards
Depositors who have a low credit score or are New to Credit (NTC) can leverage their FDs to avail secured credit cards. The transactions made through secured credit cards are reported to the credit bureaus. Therefore, disciplined usage of such cards can help in building or improving the credit score of a depositor. This also increases loan eligibility as credit scores improve. Such cards can also be helpful for those who fail to avail of regular credit cards due to other reasons like inadequate income, location constraints, employer’s profile, or job profile.
Availability of loan against FD to cover mismatched cash flow
Most banks offer loans against FD facility, usually in the form of overdraft. A credit limit is sanctioned to the borrower based on the fixed deposit amount pledged with the bank as collateral and the interest is levied only on the amount drawn till its repayment. The pledged FDs, however, continue to earn interest 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 loans against FDs make them an excellent tool for mitigating cash flow mismatches and frequent liquidity, without requiring FDs to prematurely withdraw and incur premature withdrawal penalties.