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FDs score over recurring deposits

Anand Kalyanaraman &
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Interest rates may moderate soon. So, it’s a good idea to lock into the current high rates being offered by bank deposits. But which deposit scheme should you go for — fixed or recurring?

When interest rates on both are the same, fixed deposits score over recurring deposits. And when a fixed deposit offers higher rates, it wins hands down — thanks to both better returns and better compounding effect. Here’s why.

First-mover advantage

Say, a bank offers 9 per cent annually on both their fixed deposit and recurring deposit of one-year tenure. The interest income is compounded on a quarterly basis.

So, if you invest Rs 12,000 in the fixed deposit, you get Rs 13,117 at maturity at the end of one year. On the other hand, a deposit of Rs 1,000 each month for 12 months (totalling Rs 12,000) in the recurring deposit will cumulate to Rs 12,597 at maturity, Rs 520 less.

What explains this difference? In the fixed deposit, the entire Rs 12,000 earns interest from the start, while in the recurring deposit each Rs 1,000 earns interest only after the instalment is deposited.

Now, say, after depositing the recurring instalments, you put the remaining amount (Rs 11,000 after the first month, Rs 10,000 after the second, and so on) in a savings bank account which earns interest at 7 per cent (the highest savings bank rate today).

Even in this case, the total amount at the end of one year comes to Rs 12,999 — the sum of the recurring deposit balance (Rs 12,597) and the savings account interest (Rs 402). That is still lower than the Rs 13,117 cumulative balance in the fixed deposit.

The benefit of early start and better interest rate works in favour of the fixed deposit. The longer the tenure of the deposit, the greater is the benefit. Fixed deposits benefit more from the power of compounding.

Tax advantage

Long-term fixed deposits (five years or more) with a scheduled bank are eligible for tax deduction up to Rs 1 lakh. This improves the effective return on such deposits. No such tax break is available on recurring deposits.

There is no tax deducted at source (TDS) on the interest earned on recurring deposits. In a fixed deposit, if the interest income exceeds Rs 10,000 in a year, the bank will deduct tax at source and pay you only the balance.

But the no-TDS rule does not mean that the interest income on recurring deposits is exempt from tax. Income on both fixed deposits and recurring deposits is taxable, and certainly you have to pay taxes on both (less, of course, the amount already deducted by the bank).

When to go for Recurring deposits

If you do not have sufficient funds at the beginning and can invest only in instalments, then go for a recurring deposit. Regular savings over a long period at a healthy fixed rate of interest can translate into a significant sum.

But note that you need to be disciplined when investing in a recurring deposit. If you do not deposit an instalment, the bank may charge you a penalty. State Bank of India, for instance, charges Rs 1.50 for every Rs 100 a month for non-deposit of monthly instalments on recurring deposits with tenure of five years or less. Further, if you do not make deposits for an extended period, banks may close your recurring account.

Depositing sums lower than committed is not allowed in a recurring deposit. Some banks, though, allow deposits of amounts larger than what is committed. But here, the interest rate on the additional amount may depend on the prevalent recurring deposit rate and not the original rate.

anand.k@thehindu.co.in


Fixed deposits benefit more from the power of compounding.


(This article was published in the Business Line print edition dated July 22, 2012)
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