Term deposits and fixed deposits are among the most popular investment options in India. Although these two terms are used interchangeably, there is a subtle difference between them.
As an investor, to make well-informed decisions that align with your financial goals, you must be aware of the difference between a term deposit and a fixed deposit. In this article, we are going to delve into these two investment options, explore their features and benefits, and compare them with one another.
What is a Term Deposit?
A term deposit is an investment option that banks and non-banking financial institutions offer. Here, you deposit a sum of money for a predetermined period, known as the ‘term’, of your choice.
In exchange, the bank or financial institution pays interest at a fixed rate on the amount you deposit. The principal amount of the investment, along with the accumulated interest, is paid out once the term ends.
What is a Fixed Deposit?
A fixed deposit, or FD, is a type of term deposit that financial institutions offer. Here, you invest a lump sum of money for a fixed period in exchange for interest at a particular rate. With a fixed deposit, you can choose to receive interest payouts at regular intervals and the principal once the tenure ends, or you can opt to receive both principal and interest at the end of the tenure.
Recurring Deposit: The Other Term Deposit
Term deposits can be of two types: a recurring deposit and a fixed deposit. Since we have already covered what an FD is, let us now explore the concept of a recurring deposit before moving on to the comparison of term deposits vs. fixed deposits.
A recurring deposit, also known as an RD, is another type of term deposit where you invest a fixed amount of money at regular intervals for a particular term of your choice. At the end of the term, you will receive the total amount you have deposited along with the accumulated interest.
Term Deposit vs Fixed Deposit
The primary difference between a term deposit and a fixed deposit is the terminology and what it signifies. Term deposits encompass two different types of investments, namely, fixed deposits and recurring deposits. A fixed deposit, meanwhile, is merely a subset of a term deposit.
Fixed deposits and recurring deposits, on the other hand, have a plethora of differences between them. For example, in a fixed deposit, you invest a lump sum amount of money for a tenure of your choice. The interest is calculated on the lump sum amount you invest at the time of opening an FD account and is compounded annually.
In a recurring deposit, you invest a fixed sum of money each month until the end of the tenure. The interest is calculated regularly on the accumulated balance in the recurring deposit account, which grows with each deposit. Also, the interest is compounded quarterly. Since you don’t have to invest a lump sum upfront, recurring deposits offer more flexibility compared to fixed deposits.
Taxation of Term Deposits in India
Now that you have understood the difference between a term deposit and a fixed deposit, let us look at how the two types of term deposits are taxed in India.
The interest you receive at the end of the term from a term deposit, be it a fixed deposit or a recurring deposit, is fully taxable. It is added to your total income and is taxed at the income tax slab rate applicable to you.
That said, some banks offer a special type of fixed deposit with a tax benefit. Known as a tax-saving fixed deposit, the amount you invest in this FD can be claimed as a deduction under Section 80C of the Income Tax Act, 1961. The maximum amount you can claim per financial year is limited to ₹1,50,000. By claiming the amount you invest in a tax-saver FD as a deduction, you can effectively reduce your taxable income and, consequently, your tax liability.
However, there are a couple of points you should note. Tax-saving fixed deposits come with a lock-in period of five years, meaning that you cannot prematurely withdraw your investments before the end of the five-year term. Also, the interest from the FD will continue to be fully taxable.
Choosing Between the Two Types of Term Deposits
Now that you know the difference between a term deposit and a fixed deposit, here are a few factors you must consider when choosing between the two.
- Financial Situation
You could consider investing in a fixed deposit if you have access to a lump sum amount. Otherwise, investing in a recurring deposit may be ideal for your financial situation.
- Interest Rates
The interest rates on fixed deposits usually tend to be slightly higher than those on recurring deposits. Therefore, if you wish to earn a higher return on your investment, a fixed deposit may be a more suitable option.
- Minimum Deposit Requirement
The minimum deposit requirements for fixed deposits often tend to be much higher than those for recurring deposits. Some banking institutions enable you to start an RD with a monthly investment as low as ₹100.
Conclusion
With this, you must be aware of the difference between a term deposit and a fixed deposit, including the various points of distinction between the two types of term deposits. Although they are used interchangeably, ‘term deposit’ has a much broader meaning and includes fixed deposits and recurring deposits.
If you are looking for a safe and low-risk way to earn interest on your savings, investing in term deposits could be the right way to go. By including both fixed and recurring deposits in your portfolio, you get to enjoy benefits like flexibility, guaranteed returns, and capital preservation.
FAQs
Do term deposits and fixed deposits have insurance coverage?
Yes. Term deposits and fixed deposits offered by scheduled commercial banks are covered by the Deposit Insurance and Credit Guarantee Corporation (DICGC) for up to ₹5,00,000.
How is the interest on fixed and term deposits taxed?
The interest you earn from fixed and term deposits is added to your total income and is taxed according to the income tax slab rate applicable to you.
Is it possible to prematurely withdraw my investment in a fixed deposit?
Yes. You may prematurely withdraw your fixed deposit. However, most banks and financial institutions will levy a penalty for doing so.
Are fixed deposits better than a savings bank account?
Fixed deposits and savings bank accounts have their own set of advantages. While savings accounts offer liquidity, fixed deposits offer better interest rates. Therefore, when choosing between the two, make sure to consider factors like your financial goals, liquidity profile, and investment horizon.
Which of the two offers better interest rates: a short-term deposit or a long-term deposit?
Generally, long-term deposits tend to offer better interest rates than short-term deposits. However, it is important to note that the rate of interest is dependent on factors other than tenure as well. These include the type of deposit, the financial institution, and the prevailing interest rates in the economy.