The Good Old Fixed Deposit!

We all love the good old fixed deposit. A fixed deposit also known as a term deposit is a simple product which offers safety and security. It is valued amongst people and has stood the test of time. So what should we look at before investing in a fixed deposit? Let us have a closer look.


Interest Rates
Interest rates on a fixed deposit vary based on the tenure. Usually, the longer you keep your money locked into an FD, the higher interest you will get. E.g. interest rate is more for a one year FD compared to a six month FD. Interest rates also peak at a certain tenure and then stagnate or fall.
Let us look at the table of interest rates from a bank. I took the following table from the State Bank of India website. https://www.sbi.co.in/user.htm?action=viewsection&id=0,16,384,385

Tenors	Existing for Public	Revised For Public w.e.f. 18.02.2014	Existing for Senior Citizens	Revised for Senior Citizens w.e.f. 18.02.2014
7 days to 90 days	7.50	7.50	7.50	7.50
91 days to 179 days	7.50	7.50	7.50	7.50
180 days to 210 days	7.00	7.00	7.00	7.00
211 days to less than 1 year	7.50	7.50	7.50	7.50
1 year to less than 2 years	9.00	9.00	9.25	9.25
2 years to less than 3 years	9.00	9.00	9.25	9.25
3 years to less than 5 years	9.00	8.75	9.25	9.00
5 years and up to 10 years	9.00	8.50	9.25	8.75

In the above table, we are interested in the first ("tenors"), third ("Revised For Public w.e.f. 18.02.2014") and fifth columns ("Revised For Senior Citizens w.e.f. 18.02.2014") since those provide the revised rates. The above rates are for deposits less than 1 crore. If we take an example of a 35 year old man (John) who wants to open a term deposit for Rs.50,000 for 1 year, the interest rate given to him will be 9%. Notice that the interest rates for a one year FD and a 2 year FD are the same. It is advantageous to get a two year FD at the same rate only if you are prone to spending the money or if you think interest rates are going to fall.

Early Withdrawal
An FD offers the flexibility of withdrawing the money before the tenure is up. This is a fairly simple process where the bank has to be informed and the money will be credited to your account. Taking John's example; if he needs the money before 1 year for which he initially signed up for, he can break the FD. If he breaks the FD after 6 months (180 days), the applicable interest rate will now be 7%. If he withdraws the money after 8 months (240 days), the applicable interest rate as per the table will be 7.5%.

Penalty
Most banks charge a penalty if you withdraw early. It ranges between 0.5 to 1%. This means that if John withdraws his one year term deposit after 6 months the net interest rate he will get will be 6.5%.

              7% (interest applicable for 180 days) - 0.5% (penalty) = 6.5%. 
Note : Penalty rate at SBI is 0.5%.

No Penalty FD
There are banks which offer a no penalty FD. This means that if John withdrew his one year FD after 6 months, he will get 7% interest. It is worth hunting around a bit to find a no penalty FD.

Taxes
The interest of FD's is taxed as per your income tax bracket. If you fall under the 30% tax bracket, interest will be taxed at 30%.

Form 15G/ Tax Deducted At Source
If the interest from the FD is more than Rs.10,000, a tax of 10% will be levied at source. If you do not want tax to be deducted at source you can fill up form 15G (if you are less than 65 years of age) or 15 H (for senior citizens) so that tax is not deducted.

An FD is a comfort zone for most people. Taxes tend to eat into the income if you fall in the higher tax bracket. It is advisable to shop around for the highest interest rates since rates that different banks offer are different. Note that SBI was just an example I took and it may not offer the highest interest rate.