Fixed deposits have always been popular due to their characteristics of safety of capital and a surety of returns. The high interest rates of the past few years have further increased the popularity of fixed deposits as an investment.
Since June 2012 however, the RBI has cut the repo rate and cash reserve ratio several times and so in this falling interest rate scenario, it would be better to lock in your money in long term Fixed Deposits if they are your investment de jour.
Here are some tips for you to follow when you invest in fixed deposits.
1. Fixed deposits with Banks upto Rs. 1 lakh only are backed by deposit insurance, hence it would be better to split your 5 lakh investment into 1 lakh FDs in different banks.
2. The biggest risk that fixed deposits face is the interest rate risk i.e. the risk of your money being locked up for a long tenure at a low rate of return. To overcome this, ‘ladder’ your investments or split the amount available for investment in FDs into smaller amounts, each at different tenures. So while one FD is for 1 year, another is for 2 years and so on.This strategy not only ensures a regular stream of income but also safeguards the investments from interest rate fluctuations because you now have the option of reinvesting the deposits on maturity.
3. Public sector banks offer a higher return on fixed deposits than private banks, so you get higher return, more safety and security here vs private banks.
4. Senior citizens usually get better rates.
5. Opt for a FD where interest is compounded at shorter time periods like quarterly under the compound interest method.
6. Fixed deposits are also issued by companies, NBFCs and cooperative societies. The interest rates being offered here will be higher as there is more risk. So when selecting company fixed deposits, you need to evaluate the corporate name, business prospectus and financial healthof the issuing entity. These company FDs are rated by agencies like CRISIL. So pay special note to these investment grades and then take a decision which FD to invest.
7. Interest earned from fixed deposits is tax adjusted not tax free. This interest income is taxable under the head ‘ Income from Other Sources’ and you pay tax depending on the tax slab you belong to. Interest income from FDs upto Rs.10,000 is exempt from tax. TDS is deducted on income above this limit directly by the Bank – at 10% if PAN details are available and at 20% if these details are not available. If your total taxable income is below the basic exemption limit, you need to submit a declaration to avoid TDS. Form 15G is to be used by individuals below 60 years, HUFs and trusts, etc and Form 15H by senior citizens and those above 80 years. This will avoid having to claim for refund later in your return. Again this TDS can be avoided if you break the total FD amount and take smaller FDs in different banks.
8. If your taxable income is more than Rs 5 lakhs, then on your FD interest income that is more than Rs.10,000.you will need to pay additional tax according to your tax slab.
9. Fixed deposits upto 1 lakh taken for a period of 5 years are eligible for deduction from taxable income under Section 80 C.
10. Last but the not the least, even if you have FDs in the names of your family members not employed like your spouse and children, the interest income from these investments has to be clubbed with your income and tax paid if total is more than Rs.10,000.
Do note that you should look at returns from Fixed Deposits after taking into consideration tax, if applicable and definitely, the prevailing inflation. Often returns from fixed deposits in the light of the high inflation can be negative.
RBI is likely to continue cutting rates through the year and Banks/corporates will adjust FD rates downward while retail inflation is unlikely to come down substantially. So it will be the medium and long term debt investments which will see positive return and not short term fixed deposits.