Fixed deposit is one of the favored financial products in India to which most of the Indians are investing their hard earned money for a higher return. As the name suggest, money of investors are kept into this account for a predefined fixed tenure at a pre-agreed interest rate.
However, like any other financial product, fixed deposit also has its own merits and demerits. In this article, let us discuss the drawbacks of investing in fixed deposit scheme of a bank or any other financial institution.
Tenure of Fixed Deposit
One of the major drawbacks of fixed deposit is that you are putting your money for a fixed tenure at a predefined interest rate. The interest rate will not be change based on the changes that happened during the tenure, by which you may end up at a low rate of return compare to the return which you are supposed to get at current market rate.
To avoid this you can take fixed deposit for a short duration instead of a long tenure.
For example, you can go for one year fixed deposit instead of 5 years. But, please remember that tax deduction on investments of less than 5 years fixed deposit is not allowed under section 80C of Income tax act.
However, if your tax deduction limit of section 80C compensate with other investments then this proposal best suits your requirements. After completing the short duration, you can reinvest that amount at the market interest rate of the same bank or in some other bank to get higher return.
Another drawback of investing in fixed deposit for a longer term is inflation. If inflation increased at a higher rate than interest rate on fixed deposit then you end up getting lower return compare to your expectation.
PSU banks offer higher return on fixed deposits compare to private banks. So we suggest you to go for a public sector bank to get higher return.
Tax on Interest income of Fixed Deposit
Interest on your fixed deposit is not tax free. Interest on fixed deposit is taxable under the head income from other sources in addition to your other incomes. Tax rate depends on your slab rates based on which you pay tax.
In absence of a Permanent Account Number or PAN, bank will be forced to deduct TDS at the rate of 20%. However you can submit form 15G or 15H if your taxable income is less than the basic exemption limit.
To avoid TDS on fixed deposit, you can also break your total fixed deposit amount into smaller denomination and invest in different banks. You can do this if you are expecting to get more than Rs. 10, 000 per year as interest.
Penalty For Premature withdrawal of Fixed Deposit
Before investing in fixed deposit, you should get the tenure of your investment right. If there is a possibility that you will be in need of money earlier to your tenure then don’t get tempted to invest in fixed deposit for a higher period to get higher return.
Withdrawing before the end of actual tenure will pay you interest that is applicable between the date of creation and date of withdrawal and with that they may charge premature penalty. To avoid this you can invest for a smaller tenure and then keep reinvesting after its maturity.
Also read: How prepayment works in housing loan