After witnessing a sustained decline over the past few years, fixed deposit (FD) rates are rising again due to various domestic and global macro-economic factors. This trend is likely to continue in the near future, thereby restoring the attractiveness of FDs among retail investors.

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While the highest card rates offered by major banks range between 6.5 and 7.5% per annum, smaller private sector commercial banks are offering higher interest rates, with their top card rates ranging between 7 and 8.25% per annum. Small finance banks are offering the highest yields with their highest card rates reaching up to 8.5-9% per annum. While FDs are one of the simplest and basic of all investment instruments, there are many lesser-known facets that most FD-holders should be aware of.

FDs of up to Rs 1 lakh are safe
The Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of RBI, insures all scheduled banks through its depositor insurance program. Scheduled banks include all commercial banks, regional rural banks, small finance banks, local area banks, branches of foreign banks and co-operative banks (except primary co-operative banks). 

The depositor insurance program entitles each depositor, in an insured bank, an insurance of Rs 1 lakh in the event of a bank failure. The program covers both the principal and interest component of FDs along with savings, current, and recurring deposits. Those having deposits in multiple banks are entitled to Rs 1 lakh cover for each of the banks. Thus, bank deposits including FDs of up to Rs 1 lakh are equally safe in all banks covered by under the deposit insurance. Customers can spread their risk by distributing their FD investments across multiple banks.

Premature withdrawals would earn less
Most people open FDs on the basis of the highest card rate offered, without considering their liquidity requirements and short-term financial goals. Unforeseen exigencies or over-looked financial goals then force them to withdraw their FDs prematurely. However, banks charge penal rates of up to 1.5% on premature withdrawals and subtract them from the effective interest rates while arriving at the FD closure amount. 

The effective interest rate is usually the lower of the contracted FD rate or the card rate for the period, for which the FD remained with the bank at the time of opening the FD. To avoid unnecessary premature withdrawals and loss of interest income, factor in your liquidity and short-term financial goals while selecting your FD tenure.

Your tax liability does not end with TDS
Banks deduct TDS (Tax Deducted at Source) @ 10% when interest income from FDs exceed Rs 10,000 in a financial year. For those without PAN, TDS is deducted @ 20%. In case of senior citizens, TDS is deducted only on the interest income exceeding Rs 50,000 in a financial year. 

However, the tax liabilities of FD holders do not end with the TDS. FD interest income is totally taxable, except for a deduction of Rs 50,000 tax available to senior citizens under Section 80TTB. The interest income from FDs will be added to your total income and taxed according to your tax slab. The difference between the TDS amount and actual tax liability is adjusted while filing tax returns. Thus, factor in your total FD interest income and not the TDS, while calculating the post-tax return from FDs.

FDs in the names of family members may not save tax
Many open FDs in the name of spouse or children to reduce their tax liability. But opening FDs in the name of family members, without income source or falling in lower tax slabs, may not always save tax. Interest from FDs opened in the name of your spouse as well as your minor child, will be clubbed with your income and taxed accordingly. But there is an exemption of Rs 1,500 per annum per child. 

However, interest income from FDs opened in the name of your major child or parents will not be clubbed with your income.

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Interest income from tax-saving FDs is not tax free
Tax-saving bank FD comes with a lock-in period of five years. The principal amounts qualify for tax deductions of up to Rs 1.5 lakh per financial year under Section 80C. However, the interest earned from tax-saving FD is not tax-free. They are added to your annual income and taxed according to your tax slab.

By: Naveen Kukreja  
(The writer is CEO and co-founder, Paisabazaar.com)

Source: DNA Money