What Are Term Deposits? 

Finance

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Introduction:

Term deposits (“Term Deposits”) are fixed-term investments whereby money is deposited into an account at financial institutions like banks, Non-Banking Financial Companies (“NBFCs”), credit unions, and post offices.  The maturity for term deposit investments is between one month to a few years and are hence usually short-term, with required minimum deposits that depend on the terms and conditions offered by the financial institutions with which you are opening a term deposit account. Term Deposits are generally recommended to risk-averse investors.

Fixed deposit accounts are a popular sub-category of term deposits. 

How does a Term Deposit work:

When a customer, as a depositor, makes a Term Deposit in a particular financial institution, the financial institution may use the funds deposited to finance loans to other customers or business by using such Term Deposits. The depositor is then paid interest on the principal amount of their Term Deposit. Traditional liquid savings accounts offer a lower rate of interest than term deposits because with savings accounts it is difficult for the banks to correctly estimate the funds ready at their disposal for financing loans.

Types of Term Deposits:

Recurring Deposits:

In a Recurring Deposit (“Recurring Deposit”), a fixed sum of money is invested at a specific interval, which may be once a month or once a quarter, or once a year. This investment gradually earns interest on the principal amount until the tenor of the Recurring Deposit is complete. Upon attaining maturity, the investment is then available to be withdrawn by the customer, along with the interest accrued therein. Once the tenor of the recurring deposit is fixed, it cannot be changed. The interest rates on Recurring Deposits depend on the tenure and also vary from financial institution to financial institution.

Fixed Deposits: Fixed deposits accounts (“Fixed Deposits”) are deposits where a lump sum amount of money is invested for a fixed period of time. The time period for Fixed Deposits accounts is variable and may range from 7 days to ten years.  The FD interest rates depend on the period for which the funds are locked in. Similar to the Recurring Deposit, the amount invested in a Fixed Deposit when withdrawn prior to the completion of the Deposit tenor, the same will be subject to a penalty on the interest accrued on the principal amount. 

The Salient Features of Term Deposits are: –

Stability: Fixed Deposits accounts a sub-category of Term Deposit have a fixed rate of interest and tenure, and are not subject to market fluctuations which makes them essentially risk-free compared to other market investments. This means that investors can continue to reap the benefits of a stable interest on their Fixed Deposit, even during a crisis in the market. 

Interest Rates: Most Term Deposits have a higher rate of interest and can go as high as 10% per annum, as against traditional liquid savings accounts, however, in the case of savings account customers can withdraw their money at any time.

Rollover: Financial institutes encourage customers to reinvest their principal amount and interest accrued into a new Term Deposit. This facility is commonly known as “Rollover”, which means the reinvestment of maturity proceeds into a new term deposit, thereby not requiring the customer to withdraw their Term Deposit upon maturity.

Loan Sanction: Financial institutes that offer secured loans may issue such loans against fd. In this case, the customer can pledge their Term Deposit as security and have a loan sanctioned to them. The amount on the Loan may be as high as 90%-95% of the deposit amount, depending on the financial institution.

Insurance on Deposit: As per an RBI Press Release any deposit in a certified bank is eligible for an insurance cover of up to Rs. 5 Lakhs under the Deposit Insurance and Credit Guarantee Corporation, which has been effective from the 4th of February, 2020. The Deposit Insurance and Credit Guarantee Corporation is a wholly-owned subsidiary of the Reserve Bank of India, that previously provided an insurance cover of up to Rs. 1 Lakh against deposits in a certified bank.

Low Investment Limit: the lower limit of the term deposit may be as low as Rs. 1000, however, this may vary depending on the financial institution, while no upper limit is set on the principal amount deposited in a Term Deposit.

Taxation on Interest: As per the Income Tax Act, 1961, the interest earned on a Term Deposit is taxable income and can be subject to Tax Deducted at the Source (TDS). Further, if the Term Deposit account is a tax-saving fixed deposit account, then such an account can be subject to a tax deduction under Section 80C of the Income Tax Act,1961. Here, the customer can claim a deduction of upto Rs. 1.5 Lakh per annum by investing in a tax-saving fixed deposit account.

Penalty on premature withdrawal: Term Deposits are subject to a fixed tenor, wherein the principal amount is considered locked in. If the depositor withdraws the deposit before the tenor is complete, they shall be liable to forfeit the interest accrued on the principal amount. The extent of forfeiture of interest depends on the time period from the initial deposit to the date of withdrawal.

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