The recent 50bps rate cut by the US Federal Reserve has raised expectations that the RBI will follow suit, or at least shallower interest rate policy. Although the repo rate cut should reduce borrowing costs for new and existing borrowers, especially those with loans linked to the repo rate, yields on term deposits opened after the rate cut are likely to fall. . As many banks are still offering attractive interest rates on FDs, depositors with surplus should preferably book long-term FDs to get higher real interest income after the interest rate regime flips. may decide.
Here, we discuss some FD factors and benefits that will help FD depositors take the best decision.
Term deposits opened with high-yield banks are also covered by deposit insurance.
Deposits of up to Rs 500,000 opened by each depositor with each scheduled bank will be covered by the deposit insurance program of Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of RBI. This insurance program covers term deposits as well as deposits maintained in savings, term deposits, and checking accounts. The main purpose of this insurance program is to protect depositors from the risk of losing their deposits due to bank failure. Both interest and principal of eligible deposits are insured under this program.
Currently, most small finance banks are offering interest rates that are 100 to 150 bps higher than PSU banks and large private banks. Banks like Suryoday Bank and Unity Bank offer FD interest rates of over 8% per annum for a tenure of 5 years or more. The insurance cover of Rs 50,000 is applicable separately to the deposits maintained with each scheduled bank, so risk-averse investors can benefit by spreading their FDs across multiple small finance banks. You can increase your effective insurance coverage.
Ignoring liquidity requirements and investment period can result in penalty interest rates Many depositors ignore important factors such as liquidity requirements and investment period and base their FD solely on the interest rate offered. Select a retention period. Therefore, due to unexpected financial emergencies or oversight of financial goals, such depositors may close their FDs before the maturity date. Note that most banks impose an early withdrawal penalty of up to 1% for premature or partial withdrawals. This penalty interest rate is deducted from the effective interest rate of the FD. This is usually the lower of the contracted FD interest rate and the FD interest rate for the period the FD remains open. Therefore, depositors should take into account the investment horizon of their liquidity requirements and financial goals to reduce the risk of incurring early withdrawal penalties.
Tax-saving FD does not generate tax-free income
Section 80C of the IT Act allows tax deduction of up to Rs 1.5 million per financial year on investments in tax-saving FDs. These tax saving FDs have a lock-in period of 5 years. However, like any other FD, the interest income earned from a tax-saving FD is also taxable as per the depositor’s tax schedule. Only the interest income earned by senior citizens from tax-saving FDs is eligible for tax deduction under Section 80TTB. This section allows tax deduction of up to Rs 50,000 to senior citizens on interest income earned from various deposits (including FDs) kept in banks and post offices.
Since the after-tax returns from tax-saving FDs usually cannot exceed the inflation rate, especially for investors in high-tax slabs, risk-averse investors seeking above-inflation returns can instead opt for PPF, NSC, Sukanya -You can consider small savings schemes such as Samriddhi Yojana. This provides Section 80C benefits and tax-free filing. Those with a higher risk appetite can opt for Equity Linked Savings Schemes (ELSS) for higher post-tax inflation-adjusted returns. These funds have a lock-in period of just three years, one of the shortest lock-in periods of any tax-deductible investment product.
Improve your credit score and manage cash flow discrepancies with FD
Many banks offer depositors access to term deposits through secured credit cards or overdraft facilities. Financing against fixed deposits is provided in the form of an overdraft facility and is therefore an excellent tool to reduce cash flow mismatches that often occur. The bank charges interest only on the amount from the overdraft limit until it is repaid and the depositor continues to receive interest on the pledged FD during the loan period. Secured credit cards provide additional convenience for individuals who are unable to qualify for regular credit cards due to credit score or other eligibility requirements. Secured credit cards also help individuals steadily build/improve their credit scores as banks report secured card transactions to credit bureaus. Therefore, disciplined use of a secured credit card can help cardholders steadily build or improve their credit score. Similar to loans against FDs, depositors availing secured cards continue to accrue interest income from pledged FDs.
Your tax liability doesn’t end with TDS
The income tax liability of an FD investor does not end with TDS deduction by the bank. While TDS is deductible at the rate of 10% (20% for depositors who have not provided PAN), the interest income earned from FDs is taxed as per the depositor’s tax schedule. Further, if the total FD interest income deposited by the bank in each financial year is less than Rs 40,000, the bank will not deduct TDS. The difference between the total TDS deduction and the actual tax payable on FD interest income is adjusted at the time of filing the income tax return. Therefore, the depositor should always take the tax slab into account while calculating the after-tax return from the FD. This helps you make a more comprehensive comparison between term deposits and other fixed income products such as bond mutual funds and bonds.
Conclusion:
A reversal of the high interest rate regime appears imminent, at least within the next few months. However, depositors should not ignore the investment horizon of their liquidity requirements and short-term financial goals to select the holding period that offers the best FD slab interest rate. You can also diversify your FDs in small finance banks that offer high-yield FDs to earn higher risk-adjusted returns. Individuals can also leverage FDs to address frequent cash flow discrepancies and build/improve credit scores, if allowed by banks.
(Gaurav Aggarwal, Chief Business Officer, Unsecured Loans, Paisa Bazaar)
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Published October 14, 2024
