How Does Fixed Deposit (FDs) Work?
Updated on: Sep 21st, 2023 | 10 mins read
Fixed Deposits (FDs) are a natural choice for investors exploring investment options that involve minimal risk and offer assured returns. If you have a lump sum surplus to invest, depositing it to an FD account instead of a savings account would be wise because the returns offered by FDs are higher than a savings account.
You can open an FD account with a bank, a deposit-taking Non-Banking Financial Company (NBFC) or at a post office. While the minimum investment amount varies across financial institutions, there is no limit on the maximum investment.
But have you wondered how a fixed deposit works? How do banks benefit from your FD account? In this article, we decode these underlying concepts while introducing you to the different types of FDs.
How Does a Fixed Deposit Work?
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, and this tenure can range anywhere between seven days and ten years. Now, let us look at the fundamentals of how a fixed deposit account works.
Suppose you chose a two-year tenure for a deposit of Rs. 50,000 in a bank. 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.
The interest rates offered on FD vary across institutions and are based on your investment tenure and amount. Each financial institution fixes its interest rates depending on the repo rate changes, as announced by the Reserve Bank of India (RBI), from time to time. The important point to remember is during your FD tenure, even if interest rates fluctuate, you will be entitled to the rates promised at the time of opening the account.
However, the scenario changes when you withdraw prematurely. In this instance, you need to pay a penalty or withdraw at a lower interest rate than the predetermined rate.
So, banks utilise your funds for a fixed tenure and in return, it pays you a predetermined interest on the deposit.
Types of Fixed Deposits
Now let’s look at the various types of FDs.
1. Standard Fixed Deposits
A standard FD is an FD scheme in which you can invest a lump sum amount for a fixed tenure at a fixed interest rate. This interest rate set by the bank remains the same throughout the predetermined tenor and is typically higher than a savings bank account. This tenure may vary from seven days to 10 years, depending on the financial institution where your account is being opened.
2. Corporate Fixed Deposits
Investors can make deposits with corporates in order to yield high returns in comparison to Standard FDs.Generally, financial institutions and deposit-taking NBFCs (Non-Banking Financial Companies) offer such deposits.
These deposits are risky and unsecured i.e if the company defaults, investors might not be able to recover the amount.
3. Tax-saving Fixed Deposits
A tax-saving FD is an FD scheme that allows you to save taxes on the gains from your deposits. As per Section 80C of the Income Tax Act, 1961, you can avail tax deductions on investments up to Rs. 1,50,000 per year. However, in this case, the lock-in period would be five years.
4. Cumulative Fixed Deposits
Under this scheme, your interests will be accumulated until maturity, with periodic compounding. The interest earned every year gets added to your principal amount and is paid upon maturity. Generally interest is compounded quarterly in case of cumulative FD.
5. Non-cumulative Fixed Deposits
In a non-cumulative FD, the interest income is paid at specific intervals – monthly, half-yearly, quarterly or yearly.
6. Senior Citizen Fixed Deposits
People above the age of 60 years are eligible to open a senior citizen FD account. The interest rate provided in this FD scheme is higher by 0.5-0.75% than the interest rate provided on standard FD schemes.
A senior citizen can claim savings and fixed deposits interest deduction restricted up to Rs 50,000 under section 80 TTB; the provision is exclusively for senior citizens.
7. Flexi Fixed Deposits
A Flexi FD is formed by combining a fixed deposit and a demand deposit. It allows investors to enjoy the liquidity of savings or current accounts and the higher interest rates offered by an FD account. Here, you link an FD account with a savings account.
After making an initial deposit in an FD account, you set the balance limit for your savings account. Flexi deposits have access to the auto sweep feature if the balance in the savings account exceeds the limit, the excess amount can be transferred to the FD account automatically.
Final thoughts
FD is one of the safest investment instruments you will come across. However, knowing how a fixed deposit works will not be enough to help you make a decision; you should also consider parameters like interest rate, tenure, maturity amount, and terms and conditions related to premature withdrawal before investing in a scheme.
Additionally, and most importantly, assess your financial goals before investing.
FAQs
Do banks provide a facility to open an FD account online?
Yes, you can open an FD account online with most banks. This facility can be availed through the bank’s internet banking portal or application. In fact, India Post also offers online account opening facilities for FDs via its internet banking service.
Can I change the tenure for my FD investment?
The investment tenure for an FD account remains fixed. You cannot change it once you open an account. However, you may be allowed to withdraw prematurely after paying the penalty.
Who can open an FD account?
The following individuals and organisations are eligible to open an FD account:
- Indian residents
- Non-resident of India (NRI)
- Senior citizens
- Minors
- Sole proprietorship or partnership firms and companies
- Family trusts, societies, and clubs.
Can I save tax by investing in an FD scheme?
Yes, you can invest in tax-saving FD schemes. This scheme allows you to avail tax deductions on investments up to Rs. 1,50,000 per year, as per Section 80C of the IT Act. Generally, these FD schemes come with a lock-in period of five years.
Can I link my FD account with my savings account?
Yes, you can link your FD account with a savings account. For Flexi FD and sweep-in FD, you can set a limit on the balance in your savings account. If your balance exceeds the limit, the excess amount can be transferred to your FD account.
returns on FD
Lock in returns as high as
8.35% before they go down
Top Banks FD Schemes
Top Banks FD Rates
Understanding Fixed Deposit
Recent Blogs
