Opening bank fixed deposits? Here are some important facts that you should know

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Bank fixed deposits are probably the most popular investment option among low risk investors due to their high income certainty and capital protection.

Many risk-averse investors also use fixed deposits to achieve their long-term goals. However, low investor awareness regarding bank fixed deposits often lead depositors to make sub-optimal investment decisions while opening fixed deposits.

Let’s take a look at five crucial facts regarding fixed deposits that depositors should know:

— Fixed deposits of all scheduled banks are covered under the deposit insurance programme

Fixed deposits opened with scheduled banks are covered under the depositor insurance program offered by the DICGC, an RBI subsidiary. The insurance cover is applicable on cumulative bank deposits (including fixed deposits, current account, savings account and recurring deposits) of up to Rs 5 lakh per depositor per bank in case of bank failures.

Risk-averse investors looking for higher returns from fixed deposits while ensuring maximum capital protection should open fixed deposits with scheduled banks offering higher interest rates in such a manner that their cumulative deposits in each of the banks do not surpass Rs 5 lakh level. At present, the highest fixed deposit slab rates offered by some small finance banks and a few private sector banks are 150-190 bps higher than those offered by most private sector and public sector banks.

— Tax liability doesn’t stop with TDS

Banks deduct a TDS of 10% on interest income from fixed deposits if the interest income generated from them exceeds Rs 40,000 in a financial year. In case of senior citizens, the limit is Rs 50,000. For those who do not provide PAN numbers to their banks, a TDS of 20% is deducted from the interest income. However, note that interest income from fixed deposits is taxable according to the income tax slab of the depositor. However, senior citizens can claim a tax deduction of up to Rs 50,000 on their fixed deposit interest income. Hence, the final tax liability arising from the interest income of fixed deposits would be higher than the TDS rate for those falling in the higher tax slabs. Depositors would have to pay the difference amount while filing their tax returns. Hence, depositors should factor in tax slab rates and not TDS rates while estimating their tax liability and post-tax returns from fixed deposits.

— Premature withdrawal reduces your returns

Most banks charge a premature withdrawal penalty of up to 1% on premature closures of fixed deposits.  The penal rate is deducted from the effective interest rate, which is lower of the original booked fixed deposit rate or the fixed deposit card rate at the time of booking the fixed deposit for the period for which the fixed deposit remained in effect. Thus, ensure to factor in your liquidity requirement and time horizon of your financial goals while selecting your fixed deposit tenure.

— Opening of account in name of family members might not save tax

Many investors open fixed deposits in the name of their spouse or children to reduce their tax liability. However, fixed deposits opened in the name of your family members falling in lower income slab or having no income source might not always save tax. For instance, the interest earned from a fixed deposit opened in the name of your unemployed spouse gets clubbed with your income and is taxed as per your tax slab. While the same rules apply for fixed deposits opened in the name of your minor ward, an exemption of Rs 1,500 p.a. per child is permitted. However, interest income earned from a fixed deposit opened in the name of your major ward or parents do not get clubbed with your income.

— Interest income from tax saving fixed deposits is not tax-free

Section 80C permits taxpayers to claim a deduction on tax of up to Rs 1.5 lakh every financial year for investments in tax saving fixed deposits. However, the interest earned from the tax saving fixed deposits is taxed as per the tax slab of the depositor. Moreover, such fixed deposits come with a lock-in period of 5 years. Thus, for those in the higher tax slabs, their post-tax return from tax saving fixed deposits may not even beat the average inflation rate during the entire fixed deposit tenure. Instead, taxpayers with moderate to high risk appetite should consider Equity Linked Saving Scheme (ELSS) to save tax under Section 80C. ELSS primarily invests in equities, which as an asset class usually beats inflation rate and rate of returns from fixed income instruments by a wide margin over the long term.

(The writer is Director, Paisabazaar.com)