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Tuesday, July 16, 2013

Are You Getting Optimum Returns On your Fixed Deposits ?

Update:As per finance bill FY 15, the exemption limit of Rs. 10,000 on deposits will be per bank basis and not per branch basis.


Many people book theirs FDs just by considering a suitable combination of interest rate and the tenure, but little do they know that there are 2 more factors that determine the final return.

(1) Tax Deduction at Source or TDS

The first factor is TDS or Tax Deduction at Source- A bank branch shall deduct the TDS @ 10 % when accumulated interest exceeds Rs. 10,000.
This tax deduction not only reduces your interest amount but also deprives you of future return on it. This TDS erodes a significant amount especially when the tenure of the FD is a longer one.

Let us understand it with an illustration-

An FD (with quarterly compounding option) of Rs. 5,00,000 with a coupon rate of 10 % for a tenure of 5 years, matures to an amount of Rs. 8,19,308 but when TDS is deducted maturity amount reduces to Rs. 7,80,255. 
The difference in these two maturity values is Rs. 39,053 but the total tax deducted or TDS is Rs. 31,139 only.
This means Tax deduction deprives you a return of Rs. 7,914 Rs. (39,053-31,139).
To save the TDS one has to submit the form 15 G (15 H in case of senior citizens).
But this option is available to investors whose income don’t exceed basic income tax exemption limit.

So, what investors who are not eligible to submit these forms should do?

They can save the TDS by judicious money management using internet banking (and this is 100 % legal). I have discussed this in detail here.

(2) Compounding Option

If you don't need money then never ever choose the Interest Payment option but instead opt for Reinvestment of the Interest. Banks generally compound the interest quarterly.

Let's see an illustration-

Mr. Sharma opens an FD account with a tenure of 5 years for a principal of Rs. 5 lakh (.5 million) at a coupon rate of 10 % and opts for a Quarterly Interest Payment

Mr. Verma too goes for a similar FD but chooses Quarterly Interest Compounding option.

After 5 years, Mr. Sharma gets a total interest of Rs. 3,14,123 Rs. (including saving Interest on the FD interest) while Mr. Verma gets a total interest of  Rs. 3,19,308 (Rs. 5,185 more than Mr. Sharma).
Simply put, the interest earned by the FD fetches Mr. Sharma a meagre 4 % saving bank interest return while the same in case of Mr. Verma fetches 10 % FD return.
So, moral is, if you don't need the money then you should always choose the Interest Reinvestment option for your FD.

PS: Having read this article a person commented-

Sorry mate this is terrible advice. If income from FD falls above taxable limits the entire income is taxable. Even if you open multiple FDs to ensure no TDS you still need to pay up what you owe.

and answer to his concern is-

This article does not say how you can save the income tax but rather emphasizes on  how 'tax deduction' reduces your returns and by saving  this 'tax deduction' how you can optimize your returns.
Saving the TDS does not mean tax exemption.

Hope it helps.

1 Comments:

freefincal.com said...

Sorry mate this is terrible advice. If income from FD falls above taxable limits the entire income is taxable. Even if you open multiple FDs to ensure no TDS you still need to pay up what you owe.

You are probably going to delete this comment. At get your facts straight before your post.

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