What is a Term Deposit: Formula, Calculation, Types and Examples
What is a Term Deposit / Time Deposit?
“Term Deposit” or “Time Deposit” is an investment instrument, in which a lump-sum amount is deposited at a predetermined rate of interest for a fixed period of time ranging from one month to 10 years. Financial institutions such as banks, non-banking financial companies (NBFCs), credit unions, post offices, and building societies offer term deposits.
This blog provides an overview of Term Deposits and how they work. Let’s dive in!
How Does Time Deposit Work?
A time deposit freezes a certain amount of money for a fixed duration ranging anywhere from 5 years to 10 years at a fixed rate of interest. Term deposit interest rates are determined by the length of time the funds are deposited with the bank. The depositor cannot withdraw the funds before the due date. However, some banks allow premature withdrawal but with an additional penalty. The principal and interest are credited to the depositor’s bank account on the day of maturity by the bank.
Term Deposit Example
Here’s an example of a term deposit to help you understand!
For example, if you choose to invest ₹25,000 for three years at a 7.1% annual interest rate, a cumulative TD would have a maturity value of ₹30,712. Interest is earned at a rate of 7.1% per year. Non-cumulative TDs, on the other hand, pay out interest on a regular basis and lose compounding power.
Term Deposit Calculator and Formula
There are two types of FD that you may avail of – simple interest FD and compound interest FD.
The fixed deposit calculator for simple interest FD uses the following formula –
M = P + (P x r x t/100)
Where:
- P is the principal amount that you deposit
- r is the rate of interest per annum
- t is the tenure in years
Example
For example, if you deposit a sum of Rs. 2,00,000 for 5 years at 10% interest, the equation reads –
M= Rs. 2,00,000 + (2,00,000 x 10 x 5/100)
= Rs. 3,00,000
For compound interest FD, the FD return calculator uses the following formula –
M= P + P {(1 + i/100) t – 1}
Where:
- P is the principal amount
- i is the rate of interest per period
- t is the tenure
For example, if you take the same variables, the compound interest FD will accrue,
M= Rs. 1,00,000 {(1 + 10/100) 5-1}
Or, Rs. 1,61,051
Features of Time Deposit Account
Before opening a term deposit A/C consider the following features.
1. Fixed-date Withdrawal (Maturity Rate)
The rate of time deposit Interest is fixed and is not subject to fluctuations in the market.
2. Safety of Investments
Since interest rates of the time deposit are not affected by the changes in the economy, it is one of the safest investment options available.
3. Wealth Generation
The steady interest on the investment guarantees that the investors’ wealth increases even when the market is unstable.
4. Rollover
If an investor does not need their money at the maturity of their time deposit, they can roll it over for a new term. The term ‘rollover’ refers to the reinvestment of maturity proceeds in a new time deposit and the addition of interest. As a result, an investor is not required to use their money as soon as the time deposit matures.
5. Loan Against Deposit
In case the investor is in need of liquidity, they can seek a loan of up to 60-75% of the deposit amount.
6. Taxation on Time Deposit Interest
Time Deposit Interest income can be taxable under the Income Tax Act and can be subject to a Tax Deducted at the Source (TDS).
7. Low Investment Limit
The lower threshold of investment varies for each financial institution, but the lower limit is generally Rs 1,000. However, there is no upper limit on how much can be invested in term deposits.
8. Penalty on Premature Withdrawal
Term deposits are considered ‘locked-in’ because they have a fixed tenor. If the investor chooses to withdraw from the deposit before the lock-in period expires, they must pay a penalty to the financial institution as well as lose interest income.
Benefits of Term Deposit
1. Encourages Savings
Term deposits encourage you to save money. It is a type of investment that allows you to grow your money while also making it easier for you to meet your future financial goals by providing attractive interest rates.
2. Get Loan Against TD
You can borrow money against the money in your Term deposit account. The loan amount is determined as a percentage of your TD account balance. It is usually between 60% and 90% of the amount in your deposit account. You can use this TD benefit if you require emergency funds quickly.
3. Tax Benefits
Depending on the type of fixed deposit account you select, there are tax-saving TDs with a 5-year lock-in period. Under section 80C of the Income Tax Act of 1961, the amount you invest in these term deposits is deductible from your total taxable income.
4. Assured Returns
Term deposits provide guaranteed returns because the interest rate remains constant throughout the term of the deposit. Furthermore, you will earn guaranteed interest at this rate, eliminating all financial uncertainty.
5. Flexible Duration
One of the most important advantages of TDs today is their flexibility in terms of investment tenor. You can select from a variety of deposit periods ranging from as little as 7 days to as much as 10 years or more. Term deposits are thus appropriate for your short-, medium-, and long-term financial objectives.
How to Invest in a Term Deposit?
- Step 1: Compare TD’s
Interest rate on TDs varies from one financial institution to the next, NBFCs and small finance banks may offer higher interest rates than commercial banks. Senior citizens are also entitled to higher rates of return on their investments. - Step 2: Choose Deposit Tenure
A TD scheme typically has a tenure ranging from 7 days to 10 years. You should then choose a suitable deposit tenure based on your needs. - Step 3: Select the Frequency of Interest Payments
After you’ve decided on the TD tenure, you can choose how frequently you want to receive interest payments. In general, you have the option of selecting any of the following.- Monthly
- Quarterly
- Half yearly
- Annually
- Step 4: Select Mode of Deposit
Finally, decide which deposit method is best for you. Most financial institutions permit TD holders to deposit funds via net banking or by visiting their local branch. Then you can proceed to fill out a TD application form and invest in a scheme.
Types of Time Deposit
The term used to describe time deposit varies depending on the financial institution. Certificate of Deposit (CD), term deposit, or fixed deposit are all terms that are commonly used. Furthermore, in some countries, post offices offer investment vehicles such as Post-Office time deposit Schemes.
1. Fixed Deposit
A fixed deposit scheme requires a single large sum to account for a fixed tenure. The customer will be unable to access the fixed deposit until the maturity period has been completed. As a result, they are non-negotiable and non-payable on demand. A reinvestment deposit is one in which the interest earned is only accessible after maturity.
2. Recurring Deposit
A recurring deposit account allows the customer to deposit a fixed amount at regular intervals throughout the maturity period. For instance, a predefined amount is deposited monthly for a long period.
3. Sweep-in Facility Term Deposit
Sweep-in is a feature offered by financial institutions that allows individuals to determine an upper limit to their savings account. Any amount in excess of that will be taken out or rather converted as a term deposit. If the savings account is in deficit, the funds will be withdrawn from the term deposit, with a loss of only the interest on the funds swept in. Sweep-in term deposits typically offer higher interest rates.
4. Post Office Term Deposit
Post offices also offer some financial services. The Post Office Term Deposit is one such service. It can be opened as either an individual or joint account. Postal term deposit accounts can be transferred from one post office to another, or multiple accounts can be held at the same post office. The minimum deposit amount is Rs.200, and the current interest rate for 5 years is 7.9%. Any deposit with a term of more than five years is eligible for the tax benefits specified in Section 80C of the Income Tax Act of 1961.
5. Tax-saver Term Deposits
Section 80C of the Income Tax Act allows for a tax deduction of up to Rs 1.5 lakh on tax-saver deposits.
How to Open a Time Deposit Account
A term deposit application process is similar to that of a savings account. In fact, if a prospective investor opens a term deposit at a bank where they already have a savings account, the process is expedited. The majority of banks and other financial institutions have made online application and verification processes available. It should be noted that the eligibility criteria implemented by these institutions may differ, so before applying for a plan, the necessary parameters should be checked.
- Step 1: One can also opt to apply for a time deposit online through the steps mentioned (could vary with each bank)
- Step 2: The applicant needs to have an active net banking feature and a valid PAN
- Step 3: Once the user logs into his net banking portal, he gets access to the list of online services provided by the bank
- Step 4: Applicant can select the option of creating time deposit from the services
- Step 5: This is followed by entering details about one’s account and nominee details
- Step 6: The next step would be entering the amount that would be parked for the time deposit account
- Step 7: The investor needs to analyse the interest to tenor ratio before deciding the time deposit
- Step 8: If the request is successfully created, an account is created ideally within 1-2 business days
Advantages of Time Deposit Account
- Time deposits are low-risk investments
- Time deposits enable you to make money in any market conditions
- In terms of tenure, time deposit provides more flexibility. Tenure options for time deposit with banks and other financial organizations range from seven days to ten years
- Loans against deposits are a crucial feature included with time deposit that let you apply for pre-approved loans against your holdings
Disadvantages of Time Deposit Account
- Returns offered by time deposit are lower than conservative investments
- Fixed interest rates do not generally beat the inflation rate
- An early withdrawal attracts a penalty
- In case interest rates rise, the investor loses the opportunity to invest elsewhere
- Usually, treasury bills and bonds have a greater yield than time deposit interest
Things to Consider Before Choosing a Time Deposit Account
- Split your time deposit of similar tenure into smaller amounts
- Analyse your short-term and long-term goals while choosing the tenure
- Avoid opening the time deposits for long tenure
- Check the credibility of the financial institution
- Rate of penalty of premature withdrawals
Final Word
Time deposits are among the best investment tools because of the security and guaranteed returns they provide. However, it is best to assess your needs and then choose the term deposit that best meets those needs.
FAQs
A time deposit is a bank account that has a predetermined maturity date.
Usually, the time deposit interest rates vary between 2.5% – 7.5% p.a.
A Certificate of Time Deposit, CD is a fixed-income financial instrument governed by the Reserve Bank of India (RBI) that is issued in a dematerialized form. The pay-out amount is guaranteed from the start. A CD can be issued by any All-India Financial Institution or Scheduled Commercial Bank.
You can purchase a time deposit in any public or private bank
The minimum limit to open a time deposit account is usually Rs.1000 and there is no maximum limit
Yes they are the same in terms of tenure period, interest rate and nature.
Term deposits are risk-free investments because they are guaranteed by the FDIC or the NCUA. Investors can create an investment ladder by staggering maturity dates. The minimum deposit amount for term deposits is low.
Interest income from Fixed Deposits is fully taxable. Add it to your total income and get taxed at slab rates applicable to your total income.
Banks allow you to withdraw the fixed deposit amount before or after it matures.
Disclaimer
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
