At Moneylife Foundation, I have received complaints from investors regarding banks deducting money from the principal amount of their fixed deposits (FD). It is important for people to understand when and how this happens. This article aims to shed light on why this happens.
Case 1
You have a bank FD of Rs1 lakh for three years at 7%pa (per annum), and choose to receive quarterly interest payments credited to your savings account. After one year, you need money urgently, so you break the FD and instruct the bank to transfer the proceeds to your savings account. Essentially, the bank software recovers the difference between the amount of interest already paid and the interest that was due to be paid due to premature payment.
Let me explain further. You had already received a total interest of Rs7,500 on your FD, a @7.5%pa for the year. Since you broke the deposit prematurely, the interest rate applicable for the shorter period would have been less – says 6.5%pa, which works out to be Rs6,500. The extra interest of Rs1,000 that has been paid to you will be recovered from the principal amount.
Case 2
If you have the same FD of Rs1 lakh but have opted for cumulative interest, which is paid at maturity along with the principal, the value at maturity would be Rs1,07,500 (it would actually be a little higher due to compounding). If this cumulative FD is broken prematurely, the interest applicable until redemption will be re-calculated and recovered from the accumulated interest. In that case, you would receive Rs1,06,500 on closing the FD.
Tax Deduction
Tax deducted at source (TDS) is another issue people should be aware of. Interest on bank FDs is taxable, and TDS is recovered if the total interest in a financial year exceeds Rs50,000 for senior citizens and Rs40,000 for others. TDS is not recovered if form 15G or 15H is submitted. Over and above this, as per section 80TTB of the Income Tax (I-T) Act, an exemption up to Rs50,000 can be claimed by a senior citizen while filing tax returns.
A few years ago, the banking system used to estimate the total interest payable to the depositor in a given financial year and start recovering TDS, if applicable.
Under extant guidelines, TDS is recovered when interest paid exceeds the threshold tax limit. So, interest is credited in the initial months, and the TDS deduction starts once the total interest paid exceeds the tax threshold. But now, TDS has to apply to the interest that is already paid, so the amount deducted appears higher than what the depositor expects to be cut.
This also happens with a new FD is opened, and the interest due to a depositor exceeds the threshold where it is tax-exempt. For instance, suppose I am to receive Rs39,000 as interest on my existing FD in a particular year that is tax-exempt. I then open another FD, which raises the total interest receivable by me to Rs45,000 and is above the tax threshold.
In this case, TDS will apply to the total amount, and the depositor wonders why the excessive tax was deducted.
Unfortunately, bank officials are either unable or unwilling to explain and claim that it is all done by the computer—"Woh computer kya karta hai, maloom nahin."
I suggest we demand an interest certificate from the bank to understand the issue. The interest certificate has details like FD or recurring deposit (RD) number, interest paid, and TDS recovered with relevant dates.
Optimise Your FDs
Let us now see how to make the most of our bank FDs, especially since we are subject to aggressive marketing campaigns telling us to switch to mutual funds to beat inflation. The fact is that even today, FDs account for almost 40% of total savings since people find it safer. The deposit insurance guarantee has also been raised to Rs5 lakh.
Bank FDs are highly liquid and can be broken at any time. Faced with an emergency, you can even break a newly-opened FD within an hour and withdraw money. Please note this applies only to 'callable deposits', that is, deposits allowed for premature closure. A single FD below Rs15 lakh falls into this category. The tenure varies from seven days to 10 years at the applicable interest rate.
One can opt for interest payment on a monthly, quarterly, yearly basis or maturity. When it comes to monthly interest payment, one must note that the Reserve Bank of India (RBI), in its frequently asked questions (FAQs) published on 5 September 2005, has said, "as per banking practice, monthly interest may be paid at discounted value."
While choosing the frequency of interest payments, some banks credit it based on the period of deposit, while in other banks, it is liquidated based on the calendar period.
In the first case, if an FD is opened on 16th June, monthly interest is credited on 16th July, and quarterly interest on 16th September as applicable. In the second case, interest is liquidated on the last day of the month, quarter or year.
Tax Saver FDs and Sweep Facilities
One can opt for a tax-saver FD which has a lock-in period of five years. Savings in tax-saver FDs give the benefit of Section 80C of the I-T Act; however, the interest earned on the same is taxable.
One can also opt for sweep-in-sweep-out facilities offered by most banks.
Here is how sweep-in works. When the balance in your savings account reaches a certain amount, a minimum specific sum above this is automatically transferred into an FD for a particular tenure.
For example, if the balance in my savings account goes above Rs50,000, the bank will transfer Rs10,000 to a 181-day FD at the applicable interest. This deposit is further split into 10 units of Rs1,000 each. This is called a sweep-in facility.
Sweep-out is the exact opposite. I issue a cheque of Rs50,000 to someone when my savings account balance is only Rs46,000. But I have a sweep facility, so the bank will break just four units of my FD of Rs10,000 (example above) and transfer them to my savings account to make up for the shortfall of Rs4,000. This is a sweep-out.
If unused, the FD will be auto-renewed for the same period. Many bank customers find this a great convenience.
Loans & Overdrafts
Banks offer loans and overdrafts of up to 85%-90% of the principal amount of your FD. The interest charged is just 1% more than the rate for FDs. The depositor (all joint-holders if applicable) needs to sign on the back of the FD certificate pledging it to the bank till the loan or overdraft is running. On the maturity date of the FD, the outstanding amount in the loan or overdraft is automatically adjusted against the proceeds of the FD.
Such loan accounts do not require repayment in instalments, but the extra interest has to be paid without fail. It is a good option during emergencies and does not require you to break an FD.
Is this better than breaking an FD prematurely? Yes, if the loss in interest for the specified period is more than the interest applicable in the case of a loan against FD, it is a better option.
In conclusion, I would urge you to park your hard-earned money in nationalised or top private sector banks or scheduled cooperative banks. Deposits in non-scheduled cooperative banks and cooperative credit societies are avoidable.
(Retired banker Abhay Datar is a consumer activist and an expert counsellor at Moneylife Foundation. He was a member of the Managing Committee of Mumbai Grahak Panchayat (MGP) and also the treasurer at MGP for over two and a half years. After working at Bank of Baroda for 29 years, he retired as IT Manager. Mr Datar has resolved many cases related to banking and has also handled cases related to insurance and mediclaim.)
