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Fixed Deposit vs Term Deposit: Which one should you choose?

Updated on: 18 Jan 2024 | 10 min read

When building your investment portfolio, a fixed deposit is a natural choice. Moreover, FDs are considered safe and offer guaranteed returns. Most importantly, you can choose the amount you want to invest and the investment tenure based on your preferred investment horizon. With an interest rate better than a savings account, the income generated on your FD deposit can be availed as monthly payouts, making it a passive income source.

 

However, have you ever felt confused when a bank or post office representative used the words ‘term deposit’ in the context of FDs? Does it make you wonder what exactly the difference between the two is? Using term deposit while describing fixed deposit has confused many investors, not just you.

In this blog, we will compare a term deposit Vs a fixed deposit to unearth the difference between the two.

What is a Fixed Deposit

Fixed Deposits (FDs) are deposits for a predetermined period chosen by the investor at a fixed interest rate. When you invest in FDs, your money gets locked for the selected investment tenure, which can range between seven days and ten years. Now, let us look at how a fixed deposit account works.

Suppose you chose a two-year tenure for a bank deposit of Rs. 50,000. With the assurance that your investment is locked for the specified period, banks will utilise it for lending to borrowers – individuals or corporates. Banks function under an asset-liability management system. Your deposits are liabilities for banks, and the loans provided are assets. So, in opening an FD account, you are building liabilities for the bank.

Features of Fixed Deposit

The features of a fixed deposit are as follows:

  • Fixed Interest Rate: One of the key features of an FD is that it offers a fixed interest rate for the entire investment duration. 
  • Tenure: FDs have a fixed tenure ranging from a few months to several years. You can choose a tenure that suits your investment goals when making FD.
  • Minimum Investment Amount: Banks and financial institutions have a minimum investment amount for FDs. This can vary from bank to bank and can be as low as a few thousand rupees.
  • Tax Implications: The interest earned on FDs is taxable per the Income Tax Act. However, senior citizens can avail of higher interest rates and tax exemptions on the interest earned.
  • Renewal Option: At the end of the tenure, you can renew the FD for another term or withdraw the investment.
  • Loan against FD: In urgent need of funds, the investor can avail of a loan against FD. It can be upto 95% based on the Bank’s policy. 
  • Nomination Facility: FDs allow you to nominate a person who will receive the investment and interest in case of your untimely demise.
  • Premature Withdrawal: Some FDs have a lock-in period, during which you cannot withdraw your investment without incurring a penalty. However, most banks and financial institutions allow premature withdrawal in case of an emergency, subject to specific terms and conditions.

What is a Term Deposit

A term deposit differs from a savings account as it doesn't allow immediate access to funds. The money is locked in for a predetermined period in financial institutions like banks or credit unions. In exchange, depositors receive a fixed interest rate, typically higher than a regular savings account. Withdrawals are restricted during this period, and if a depositor chooses early withdrawal, the financial institution imposes a penalty based on the type of term deposit selected.

Features of Term Deposit

The features of a term deposit are as follows:

  • Fixed Interest Rate: Time deposits offer a consistent, fixed interest rate unaffected by market fluctuations.
  • Flexible Investment Period: Investors can choose the investment duration based on options the financial institution provides, with higher interest rates typically offered for longer tenures. Comparing interest-to-tenure ratios before investing is advisable.
  • Safety and Security: Term deposits provide a secure investment as their interest rates remain stable despite economic changes.
  • Wealth Generation Opportunity: Investing in term deposits is a reliable method to generate wealth, with stable interest ensuring growth even in challenging financial market conditions.
  • Consequences of Premature Withdrawal: Term deposits have a fixed tenure, and withdrawing funds before maturity results in penalties and reduced interest income.
  • Interest Payout Options: Investors can receive interest periodically (yearly, monthly, or quarterly) or after maturity.
  • Rolling Over: After maturity, investors can roll over their deposit for a fresh term, reinvesting maturity proceeds and interest.
  • Taxation on Interest: As per the Income Tax Act, interest earned on deposits is taxable income and may be subject to Tax Deducted at Source (TDS).

Difference Between Fixed Deposit and Term Deposit

Though FDs and Term Deposits are similar and often used interchangeably, they have a few differences. The table below mentions the difference between Fixed deposits and Term deposits

Basis of Comparison

Fixed Deposit

Term Deposit

Interest RatesThe rate of interest is fixed for the entire tenure of investment.The interest rate can vary depending upon the market fluctuations.
FlexibilityLess flexibleMore flexible as compared to FDs.
Premature WithdrawalAllowed with a penalty.Allowed with a penalty.
SuitabilityFDs are suitable for mid to long-term investors.Ideal for short-term investors.

Benefits of Fixed Deposit

The benefits of investing in FDs are as follows:

  • Flexibility: Fixed Deposits offer a range of tenure options from a few months to several years. This allows investors to choose a tenure that suits their investment needs and goals.
  • Easy to Open: Opening a Fixed Deposit account is a simple process that can be done at any bank of your choice. It requires minimal documentation and can be done online or offline.
  • Loan Against FD: In any financial emergency, investors can avail a loan against their Fixed Deposit account. This makes it a valuable tool for meeting short-term liquidity needs.
  • Tax Benefits: Certain Fixed Deposits offer tax benefits under Section 80C of the Income Tax Act. This makes it an attractive investment option for investors looking to save on taxes.

Benefits of Term Deposit

The benefits of investing in term deposits are as follows:

  • Deposit Commitment: Depositors commit not to withdraw funds for a specified tenure in a term deposit or fixed term deposit accounts, earning a higher interest rate.
  • Higher Interest Rates: Term deposit account interest rates are slightly higher than savings accounts.
  • Restricted Access for Higher Returns: The higher interest rates in Fixed Deposit (FD) and Recurring Deposit (RD) accounts result from limited access to funds throughout the term deposit period.
  • Safety and Guaranteed Returns: Term deposits are highly secure investments with assured returns, making them particularly appealing to risk-averse and conservative investors.

Post Office Time Deposit vs Fixed Deposit Comparison Table

ParametersPost Office Time DepositFixed Deposit
Interest Rates for Senior CitizensNo higher rate for seniors. Senior citizens are eligible for a slightly higher interest.
Interest Payout IntervalsAnnual Payouts.Annual, monthly, quarterly or half-yearly payouts, as opted for by the account holder.
Tenure1, 2, 3 and 5 years.Anywhere between seven days and ten years.
Auto-renewal FacilityOnly offered by post office branches that have core banking solutions.Provided for all fixed deposit accounts.
Loan Against DepositsYou cannot take a loan against a post office time deposit.Some banks and NBFCs extend a loan facility.
Premature WithdrawalsAfter six months, depositors can make premature withdrawals without penalty.While it differs across institutions, some provide early withdrawal without an extra charge, while others have a penalty.
TDS ApplicabilityNo.Yes, if the interest amount crosses Rs.10,000.

Which Product Should I Choose?

There are multiple parameters to consider before choosing a fixed or term deposit. Your decision must be based on your financial needs, goals and cash flow needs. Consider the following factors when selecting a term or fixed deposit:

  • Minimum Deposit Requirement

The minimum amount to open a fixed deposit varies between Rs.1000 to 5000. So, consider your finances before investing in an FD.

  • Cumulative or Non-Cumulative FDs

There are two types of FDs – cumulative and non-cumulative. The cumulative FD, also known as Special Term Deposit, means the interest is not paid regularly. Instead, it is reinvested, and you receive the entire interest income on maturity. On the other hand, a non-cumulative option means that you have chosen to receive interest payouts monthly, quarterly, half-yearly or annually, as per your needs.

  • Maturity time frame

You can open a fixed deposit with a minimum and maximum tenure between seven days and ten years, respectively. Typically, a longer-term also comes with higher interest. For instance, the post office time deposit offers a 6.9% interest rate for one, 7% for two and three years, and 7.5% for five years. Choose based on your ability to commit to a specific time frame.

  • Premature withdrawal

Banks and NBFCs vary regarding early withdrawal policies. Some banks charge a penalty on the interest, while others will merely reduce the interest amount. It is best to understand the terms and conditions in detail.

  • Collateral for loan

Your fixed deposit can be used as collateral for securing a loan. Banks typically allow a loan between 85 and 95% of the fixed deposit corpus. Understand the applicable interest rates and the principal amount you can use as collateral before applying for a loan.

  • Taxation

A tax-saver FD will be ideal if you want a tax benefit. Deposits of up to Rs.1.5 lakhs made to this scheme are tax-deductible under Section 80C of the Income Tax Act, 1961. However, the lock-in period for this FD plan is five years.

Final Thoughts

You are tempted to withdraw and spend when funds sit idle in your savings account. Hence, a fixed deposit is an effective way to inculcate a saving habit and earn guaranteed returns. Moreover, the funds earn interest, which continues to compound for the tenure of the deposit. To ensure that your FD continues to generate an income, renew it on maturity.

Hoping that this article has been able to decode the terms fixed and term deposits so that the next time you visit a bank or post office, you don’t spend time comparing term deposits vs fixed deposits. Since both are the same instruments, if required, explore other investment schemes and weigh them against a fixed deposit to decide which one suits your spending appetite and fund requirements.

FAQs

Which is better – term deposit vs recurring deposit?

While FD requires you to deposit a lump sum for a fixed period, RD is about depositing fixed amounts in small intervals over a long period. FD is a traditional and natural choice if you are a serious investor. However, RD would be more beneficial if you want to cultivate a savings habit.

Which investment instruments offer higher returns than a term deposit?

You can invest in the stock markets, mutual funds and high-yield bonds with a time horizon of three to five years for higher returns. However, all the instruments listed above are market-linked and have a degree of risk. On the other hand, a term deposit is risk-free and offers fixed returns.

What’s the risk associated with investing in a term deposit?

Term deposits are risk-free and highly secure instruments that offer assured returns. Term deposits are not dependent on market performance or affected by market volatility.

Do you pay tax on term deposits?

Yes. The interest earned on term deposits is subject to tax. The interest income is categorised under ‘income from other sources’ and taxed according to one’s income tax bracket. However, if the interest earned is less than INR 10,000, it is not taxable under the 80TTA of the Income Tax Act.

What happens when a fixed deposit matures?

On maturity, you receive the principal amount back in your savings account. However, if you have chosen a cumulative option, you will also receive interest. When opening the fixed deposit, you can also opt for an automatic renewal upon maturity. Under this arrangement, your account will be auto-renewed for the same tenure. Hence, your principal gets re-invested and is not credited back.

Can I withdraw from a term deposit?

You can withdraw prematurely from a fixed deposit and other term deposit accounts. However, early withdrawal is subject to penalties.

Are term deposits and fixed deposits insured?

Yes, the term deposits and fixed deposits are insured by the  Deposit Insurance and Credit Guarantee Corporation (DICGC).

What is the difference between short-term deposit and long-term Fixed Deposit?

A short-term fixed deposit matures within 7 days to a maximum of 2 years (24 months), while a long-term fixed deposit extends from more than two years to a maximum of 10 years. Consequently, the lock-in period for a short-term fixed deposit is shorter than that of a long-term fixed deposit.

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