NRE Deposits - Watch out for pre mature withdrawal!

If any of your siblings, friends or relatives living abroad holding NRE accounts in India, RBI has some good news for them. The interest rates on these accounts have been de-regulated, as a result many public and private sector banks have hiked their interest rates on NRE term deposits.

NRE (Non-resident External Accounts) account is a Rupee denominated account. Funds in NRE account is maintained in Indian rupees only and any interest earned on this account are exempt from tax. Funds in a NRE account are maintained in Indian Rupees and source of funds into NRE accounts must be from your earnings abroad or from another NRE / FCNR-B account maintained in India. Funds in NRE account are repatriable (That is, funds can be converted to any foreign currency). The most important feature being Interest income earned on the money in a NRE account is non-taxable in India .
 
Certainly this move of RBI has made NRE deposits particularly much more attractive in terms of returns overseas. Moreover the NRE term deposits are freely repatriable i.e. one can always convert the funds back to foreign currency and transfer it out of India

Hold your horses!  Before  you jump to invest in fixed deposits, it is advisable to know certain conditions, which your banker may not tell you while investing. In case of contingencies when you need the funds badly, then breaking your NRE term deposit may also break your heart. Your term deposits will actually give you lower returns than what you had expected if you withdraw prematurely.

Some major conditions on premature withdrawals of fixed deposits are as follows:-

' No interest is paid, if any NRE Term deposit is closed prematurely within a period of 12 months from the date of deposit.
' After completion of 1 year, the interest shall be paid only for the period for which the deposit is maintained with the Bank and at the rate applicable for such period.
' Some banks charge a premature withdrawal penalty of 0.5%-1%
There are some exceptions where it is waived like in case of death or even mental imbalance of the depositor.

So far so good until you want to make premature withdrawal. In such a scenario, it is not that only penalty affects the returns, but the actual interest also suffers on premature withdrawal of deposit. Though it may have no penalty clause but reality tends to be different.

Examples below will make this clear:

Assumed NRE term deposit rate card:

Illustration 1:

Rajesh has invested in deposit where Premature withdrawal penalty is Nil.

This way we see that if Rajesh invests in a FD for 10 year tenure and he decides to break it after 1 year, then how it will work.  Now the bank will not offer him 8.25% as per the contracted rate on the deposit maintained for a year, but the rate of interest (7.25%) prevailing for a 1-year deposit at the time he had opened his fixed deposit account.

Since the rate for a 1-year term deposit at the time of booking the FD was 7.25%, his FD will earn 7.25% interest on the principal instead of the contracted rate of 8.25%. Similarly, if he decides to withdraw after 3 years, the interest rate @ 9.25%, though higher than the contracted rate (8.25%), will be calculated at lower of the two i.e. contracted rate vis-'-vis actual duration of time the FD is kept in the bank. So he will be paid @ 8.25% interest rate only

Illustration 2:

Brijesh has invested in deposit where Premature Withdrawal penalty is 1%.

In case of Brijesh, all the terms and conditions are similar to Rajesh, except the bank levies a penalty of 1% on early withdrawal. Considering the situation, Brijesh will not only lose that extra interest but also lose by way of penalty. So his effective rate of interest will come down drastically.

Brijesh's effective return falls to approximately 6.25% for a year and 7.25% for 3 years from the initial 8.25% after taking into consideration the card rate for the duration the fixed deposit has been held with the bank and a penalty of 1%. The excess interest paid by the bank will be deducted form his principal amount while closing the deposit.

Having a few fixed deposit certificates in your portfolio is a good way of investing money, as long as you hold them till maturity. If you break them early then you are likely to pay premature withdrawal penalties. So invest wisely.

ApnaPaisa is India's leading price and features comparison site for financial products such as home loans, car loans, education loans and fixed deposits . Author can be reached at www.facebook.com/apnapaisa

Nikolai Kirtikar, Product Manager, Apnapaisa.com