It may be a good time to open a fixed deposit and lock in at high levels before the interest rate cycle turns. But before you do that, we list out the key things you need to know before investing in these fixed income options.
FDs are not entirely safe
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 insures deposits of up to 1 lakh per customer across all branches of a bank.So,if you have 3 lakh to invest,split it into 3-4 investments across different banks.This will safeguard your money and if you need the amount in an emergency,you wont have to break the entire deposit.You will have to pay the premature withdrawal penalty only for the sum that you need,even as the rest keeps growing.
Ladder your investments
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 FDs which have different tenures.If you have 4 lakh to invest,split the amount in four deposits of 1 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.
Premature withdrawals invite a penaltyLocking 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,dont be tempted to go for the longer term if 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 lowers the rate by 1 percentage point.
TDS is only an interim tax
The interest earned on FD is fully taxable.If the interest amount exceeds 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 your annual income is over 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.The tax on the interest is levied on an accrual basis.
FD income will be clubbed with yours
You cannot avoid tax if you invest in the name of your spouse or children.While you wont 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.So,if a husband invests in fixed deposits in the name of his wife,interest earned will be treated as his income.The rules are slightly different for investments in the name of minor children.The earning is treated as the income of the parent who earns more.
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