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FDs fetch fixed returns but you may miss the interest rate bus
May, 30th 2007

Tax saving is not only about public provident fund (PPF) or national savings certificate (NSC) anymore. It has a new dimension: Tax saver fixed deposits. As per Section 80 C of the Income tax Act, 1961, you can claim tax relief on investments up to Rs 1 lakh. In the case of a joint-holder deposit, the deduction from under Section 80C of the Act shall be available only to the first holder of the deposit.

Your funds will be locked in for five years. At present, returns on tax-saving FDs vary between 7.50%-8.25% per annum. Senior citizens usually earn 0.5% more than other depositors, like most other deposit products.
The minimum and maximum investment amounts (per annum) ranges from Rs 100 up to Rs 1 lakh. However, the hitch is that the contribution will be calculated for the tax break while interest earned on deposits will be taxable. Also this fixed deposit does not allow partial/premature withdrawal. Keep this in mind when you lock in your funds for five years.

Industry experts say, it does not make financial sense for borrowers, especially now, to lock in their funds at a fixed coupon rate for five years, when the interest rates are increasing by the day. In this bargain, they may just end up losing an opportunity to earn higher returns. This may pinch your pocket even more, especially when you cannot touch this money for five years.

In a rising interest scenario, locking your funds could lead to an opportunity loss of earning higher in returns. So, blocking your money now for five years is out of question as you may miss the high interest rate bus, says Karthik Jhaveri a certified financial planner.

Earn every month from FDs

Most investors look at fixed deposits (FDs) for earning a lumpsum on maturity along with accumulated interest. But, this is just one side of the deposit. You can also opt for a monthly income option in which you earn some money from your FD at a pre-determined interest rate. On maturity, you get back your principal. Typically, this option is availed by retired individuals and senior citizens, says a chief general manger with a public sector bank.

He adds, Investors of this age profile are risk-averse. Hence, they often tend to look for fixed returns on their hard earned money. So FDs score over shares or equitylinked mutual funds for them. Moreover, they enjoy a better liquidity in the monthly option than a vanilla fixed deposit product. You can open a deposit account with a minimum amount of Rs 1,000. The tenure of this scheme ranges from 1-10 years. Interest payments are subject to tax deducted at source (TDS).
Financial planners usually recommend Senior Citizens Saving Scheme (SCSS) or post office monthly income schemes for senior citizens.You earn an interest of 9%. You can opt for a monthly, quarterly, half-yearly or yearly income option and the lock in is for five years. On the other hand, post office monthly income schemes offer interest of 8%, which is taxable. The lock-in in this case is six years.

In case of premature withdrawal, which is possible only after a year, you are slapped a penalty of deduction of 1.5% of deposit if the withdrawal is between one and two years and 1% if it happens after two years.

In case of bank FDs, you are assured of the principal amount. The interest will be calculated at 1% below the rate applicable for the period of deposits.

Recurring deposits

In a fixed deposit, you put in a fixed amount at one go. In a recurring deposit, you have to keep putting in fixed amounts every month. But just like a FD, you earn your principal along with the interest component at maturity. If you do not have savings which allow you to make one time investment in FDs, RD is just right for you. This helps in long-term asset creation. For example, if you invest Rs 500 for a period of three years at 7.5%, you earn an interest of around Rs 2,115. So you earn a sum of around Rs 20,115 on an investment of Rs 18,000.

If you already hold a deposit/savings account with the bank, you can even opt for the auto debit mode. The minimum investment is usually Rs 100 but there is no upper limit in investing. In case of ICICI Bank, the minimum amount is kept at Rs 500. The rate of interest varies between 7 and 11% depending on the maturity period and amount invested. The tenure ranges from six months to 10 years. If you default in payment, the bank charges a default fee of Rs 1.50 for every Rs 100 per month for deposits up to five years and Rs 2 per Rs 100 in case of longer maturities. Premature withdrawal comes with a loss of interest.

Check your real returns

But amid all the attractive returns and the number crunching, it is pertinent for you to see the rising FD rates in the right light. Whether you actually stand to gain from higher returns can be assessed only if you compare the returns vis--vis with tax and inflation. Explains an economist with a foreign bank, in case of five year FDs, the post tax yield is around 5.48%. If the inflation at that time is 6%, your return falls below it. So always look at the post-tax yield and the likely inflation before you take the leap.

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