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Even bank fixed deposits have variants

LiveMint logoLiveMint 13-05-2014 Vivina Vishwanathan

Most Indians consider bank fixed deposits (FDs) as the safest financial instrument. “I only invest in FDs as it is easy to understand, gives guaranteed returns and the process of depositing the money is simple,” said 55-year old New Delhi-based Sunita Khurana, who has three FDs in a state-run bank that she plans to use for her daughter’s wedding. Banks, too, recognize this. “Our research showed that unlike the West, Indian consumers love bank FDs; they view it as safe,” said Brett Morgan, country head, branch banking, ING Vysya Bank Ltd.

To woo more customers, banks have introduced various kinds of FDs. “Banks are trying to customize products that benefit the customer and also garner more deposits,” said Suresh Sadagopan, a Mumbai-based financial planner. Mint Money looks at how these work.

Regular FDs

This is the simplest type. Once you have decided the tenor, you can deposit the money at a fixed rate. You get the interest on maturity along with the principal amount. Say, you invest `1 lakh for a year, and interest rate is 8.50% compounded quarterly. At maturity, you will earn `8,774, which gives you an effective yield of 8.77% (pre-tax) due to the compounding factor.

So FDs that give compounded rate of return are also known as reinvestment FDs since the interest is re-invested along with the principal. Paras Jain/Mint

If the tenor is short, seven days to six months, banks generally give simple interest, which means lower returns for you. For instance, `1 lakh at an interest rate of 8.5% compounded quarterly for six months will earn you `4,295.16 as interest, while a simple interest will mean `4,250.

You can withdraw from the FD before maturity, but there is usually a penalty of 1% on interest earned. Banks also give monthly or quarterly interest payout options.

Flexi FDs

Anirudh Sood, 24, is an information technology professional who works with a start-up in Greater Noida. He wants to save and invest but falls short of money at times. “My bank approached me with a flexi FD. It took me some time to understand the product but I realized that it’s better to put money in an FD, which gives higher interest, than leaving it in a savings account. And I can use the FD whenever I want,” said Sood.

In this product, the FD is linked to savings account, and money moves between the two. There are two options. Bank use the word flexi, sweep-in and sweep-out interchangeably

Option 1: If there is a shortfall in your savings account, the bank will automatically pull the required amount from the FD and put into the savings account. Say, you have a bank FD of `1 lakh at 8.5% interest compounded quarterly. You have issued a cheque of `50,000 but the savings account has only `20,000 in it. In such a situation, the bank will automatically transfer `30,000 (the shortfall) into your account and honour the cheque. The remaining `70,000 in the FD will continue to earn 8.5% interest.

“These deposits suit entrepreneurs and salaried customers looking for higher returns of a FD with quick and automatic liquidity options to fulfil urgent requirements,” said a spokesperson of ICICI Bank Ltd.

Option 2: In this variant, excess amount from savings account is moved to an FD. The idea is to automatically divert any surplus amount to a higher interest rate product. Say, you have `1 lakh in your savings account and have set a trigger, or the point at which money will be moved to the FD, of `50,000. The excess `50,000 will be transferred automatically into the FD. So, you will earn 8.5% on the money in the FD as against 4% that it would have earned lying in the savings account.

“Before opting for this FD, other than interest rates, you should look at the minimum balance requirement of the sweep savings accounts and the unit size needed,” said Adhil Shetty, chief executive officer, For instance, the unit size may be `1,000 or multiples of it. So, if you want to transfer `16,200, the bank will transfer `17,000. But there are banks that have a unit size of `1 as well—the exact amount will be transferred.

“Flexi FDs are for discerning customers. For example, if you know that you may have to break an FD, or that you will have excess cash in your savings account, then consider it,” said Shetty.

Overdraft FD

Overdraft facility against FD can be availed by linking your savings or current account. An overdraft is like a loan. You can usually get up to 75% of the FD amount as loan, though this limit varies. Say, you have an FD of `1 lakh with 8.75% interest rate, compounded quarterly. You take a “loan” of `75,000, which is deposited in your linked savings account (which will show a negative balance of this amount). The bank will charge an interest on the “loan”, usually 2% more than the FD rate. In our example, it will be an annual interest rate of 10.50%. Let’s say you returned the money in 10 days. You will have to pay `75,000 and interest of 10 days, `215.75.

Floating rate FD

The rate of interest is not fixed for the entire tenor, but pegged to the 364-day treasury bill rates. There is a mark-up, which is reset once every calendar year. The interest is paid quarterly and the interest rate, too, changes every quarter based on the average of treasury bill rates. This FDs work for those who want to stay with the market.

Tax-saver FD

The tenor is fixed at five years, and the amount can’t be withdrawn prematurely. Investments up to `1 lakh are eligible for income tax exemption under section 80C. But the interest you earn on maturity will be taxed according to the slab rate. Also, only notified five-year FDs are eligible for tax exemption.

You can opt for annual accrual of interest—even though the tenor is five years, you can earn every year.

What should you do?

The first thing to remember is that most FDs are tax inefficient. If you are in the 30.9% income tax bracket, an 8.50% annual return from an FD gets reduced to a net return of 5.87%. For 20.6% tax bracket, net return will be 6.75%, and 7.62% for those in the 10.3% bracket. Opt for an FD only if you are in the lowest tax bracket or have no tax liability.

Choosing the right FD variant will depend on your particular requirement—the key factor may not be interest rate, but convenience and liquidity.

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