Understand the difference between cumulative, non-cumulative FD

Fixed deposit, or FD, is one of the most popular and secure investment options. Assured returns, good liquidity, meaning the freedom to withdraw money, and being safer compared to other options make FD a preferred choice. But do you know how many types of FDs there are? Let’s discuss.

Usually, FDs come in two types: cumulative FDs and non-cumulative FDs.

What is a cumulative FD?
The meaning of a cumulative FD is an FD in which you receive both the principal amount and interest at maturity. The benefit of this is that the interest earned every quarter or annually gets added to your principal amount, and the next time you receive interest, it’s calculated on the principal plus interest. This is called compounding, which increases your return.

What is a non-cumulative FD?
In a non-cumulative FD, you choose the option of interest payment according to your preference. You can opt to receive interest every month, quarter, half-yearly, or annually.

Understanding the power of compounding through an example, let’s find out which FD, cumulative or non-cumulative, will give you more returns.

Suppose you invest one lakh rupees in a cumulative FD for 5 years with an annual interest rate of 7.10%. According to the FD calculator, in a cumulative FD, you will receive ₹1,42,175 at maturity after 5 years, including ₹42,175 as interest.

If you opt for a non-cumulative FD and choose to receive interest every quarter, you will earn ₹1,775 as interest every quarter. Over 5 years, you will earn a total interest of ₹35,500.

Before choosing between cumulative and non-cumulative FDs, it’s essential to consider tax implications. In a cumulative FD, interest reinvests, adding to the principal amount, which may lead to higher taxation on maturity. If your income falls within the 30% tax bracket, you’ll have to pay 30% tax on the interest earned.

On the other hand, in a non-cumulative FD, interest is paid regularly, and you need to pay tax on the interest earned as per your tax slab each year. For example, if you fall under a 10% tax slab this year, you’ll pay 10% tax on this year’s interest, and if next year you fall under a 20% bracket, you’ll pay tax accordingly.

Both cumulative and non-cumulative FDs are good savings options. Your choice between them will depend on your liquidity preference and investment goal. If you want to earn higher returns for short or long-term, a cumulative FD might be better for you. However, if you need regular income, like for managing expenses after retirement, a non-cumulative FD might suit you better.