Points to be considered while investing in fixed deposits
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It may be a good time to open a fixed deposit and lock in at high levels before the interest rate cycle turns but following are few important parameters to be considered before investing in fixed deposit.
1. FDs are not entirely safe
Don't think your money is completely safe when you invest in a fixed deposit. While corporate deposits are unsecured loans that do not guarantee anything to the investor, in case of banks, the Deposit Insurance and Credit Guarantee Corporation (DICGC) insures deposits of up to Rs 1 lakh per customer across all branches of a bank.
So, if you have Rs 3 lakh to invest, split it into 3-4 investments across different banks. While this will safeguard your money, an added advantage is that if you need the amount in case of an emergency, you won't have to break the entire deposit. This means that you will have to pay the premature withdrawal penalty only for the sum that you need, even as the rest of the money keeps growing.
2. Ladder your investments
Spreading your investments across different banks controls the default risk, but what about the risk of locking in your money for long periods at low rates? Fixed deposits are prone to uncertainty because interest rates tend to move in multi-year cycles. To avoid this, build a ladder of fixed deposits which have different tenures.
If you have Rs4 lakh to invest, split the amount in four deposits of Rs1 lakh each for one, two, three and four years. When the 1-year deposit matures, reinvest the maturity proceeds in the 4-year FD. By doing so, the highs and lows in interest rates will balance out over a period of time. This will also ensure liquidity because you will have one deposit maturing every year.
3. Premature withdrawals invite a penalty
Make sure you get the tenure right while investing in a fixed deposit. Locking up money for the long term and then making a premature withdrawal means lower returns. If your bank is offering a 9% interest on a one-year deposit, and 9.5% for a 5-year term, don't be tempted to go for the longer term if there is a possibility that you may need the money earlier.
If you opt for the 5-year fixed deposit and then break it after one year, you will get the rate applicable to the one-year deposit. Worse, you may be slapped with a premature withdrawal penalty that will lower the rate by 1 percentage point. So, instead of gaining half a percentage point, you may end up losing 1 percentage point. To avoid this, go for the ladder system mentioned earlier.
4. TDS is only an interim tax
The interest earned on your FD is fully taxable. If the interest amount exceeds Rs 10,000 in a year, the bank or corporate house will deduct 10.3% tax at source before you get the amount. Your tax liability doesn't end here. If you are in the higher income bracket (annual income of over Rs 5 lakh), you will have to pay more tax on this income.
Even if the TDS has not been deducted, you should mention the income from fixed deposits and bonds in your tax return. Remember that the tax on the interest is levied on an accrual basis. You may have invested in a cumulative deposit, but tax will be paid every year.
On the other hand, if your income does not exceed the basic tax exemption, you can get this TDS back by filing your tax return. To avoid the TDS, submit a declaration under Form 15G that your income is below the taxable limit. Senior citizens should submit the Form 15H.
5. FD income will be clubbed with yours
Don't think you can avoid tax if you invest in the name of your spouse or children. While you won't have to pay tax on the money given to a spouse or a child, if it is invested, the resulting income is added to the income of the giver and taxed accordingly. So, if a husband invests in fixed deposits in the name of his wife, the interest earned will be treated as his income.
The rules are slightly different in case of investments in the name of minor children (below 18 years). The earning is treated as the income of the parent who earns more. However, there is an exemption of Rs 1,500 a year per child for a maximum of two children.