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Bank Fixed Deposits (FDs) have traditionally been considered the safest and risk-free investment option among Indian households. When the capital is of a large amount like ₹ 50 lakh, most of the depositors make a lump sum FD of the entire amount directly in the same bank or for convenience, make five separate FDs of Rs 10 lakh each. At first glance, this may seem like a decision of mere convenience on paper, but when viewed through the lens of financial rules of banking and taxation, both strategies have serious flaws and risks of economic loss.
There are two most important financial aspects involved in making an FD in any bank – firstly, the legal protection of your capital and secondly, the management of penalty and tax deduction (TDS) if required prematurely. If ₹ 50 lakh is invested by ignoring these two rules, then in times of crisis, you may have to suffer a huge loss of interest or in any adverse situation, the principal amount may also be at risk.
If you make a single FD of entire Rs 50 lakh in a single bank, then the first risk is related to the financial health and legal security of the bank. As per the rules of ‘Deposit Insurance and Credit Guarantee Corporation’ (DICGC), a subsidiary of the Reserve Bank of India (RBI), only the total deposits (principal + accumulated interest) of an account holder in any one bank up to ₹ 5 lakh are insured. This means that if for some reason the bank gets into serious financial trouble, goes bankrupt or comes under strict restrictions by the RBI, then by law only the amount of ₹ 5 lakh will be considered safe and the recovery of the remaining ₹ 45 lakh may be uncertain.
The second major loss is related to liquidity i.e. emergency withdrawal. Suppose you have made a single FD of Rs 50 lakh for a tenure of 3 or 5 years and after 1 year you require only ₹ 5 lakh for any medical emergency or family purpose. In such a situation, the bank will not allow you to make partial withdrawal, rather you will have to break the entire FD of ₹ 50 lakh prematurely. By doing this, the bank deducts a premature penalty of 0.5% to 1% on the entire ₹50 lakh and you only get the lower interest rate for the actual term instead of the contracted interest rate. That is, in case of need of ₹ 5 lakh, you have to suffer huge loss on the interest of entire ₹ 50 lakh.
Many depositors divide ₹50 lakh into five FDs of Rs 10 lakh each to avoid premature penalty. Undoubtedly, this method is better than a single FD in terms of liquidity because if needed, you can break only one FD of ₹10 lakh and the remaining ₹40 lakh continues to get interest at the fixed rate. But if all these five FDs are opened in the same branch of the same bank or in different branches under the same PAN card, then the risk in terms of capital security remains the same.
As per banking rules, DICGC’s insurance cover of ₹5 lakh is applicable per bank and customer-wise and not on the basis of the number of FD accounts. Even if you have five different FD accounts of Rs 10 lakh each in the same bank, the system will consider them together as a single deposit of Rs 50 lakh and the legal insurance cover will be limited to Rs 5 lakh only. Additionally, due to deposits being made in the same bank, at the end of the financial year the bank will add the total interest of all the FDs together and deduct 10% TDS under Section 194A, which slows down the pace of compounding returns.
As per income tax rules, if the total FD interest received from a bank exceeds ₹40,000 (₹50,000 for senior citizens) in a financial year, the bank mandatorily deducts TDS. At the current average interest rate of 7% to 7.5% on Rs 50 lakh, the annual interest is approximately ₹ 3.50 lakh to ₹ 3.75 lakh. If this entire amount is concentrated in a single bank, the bank will initially deduct ₹35,000 to ₹37,500 as TDS and deposit it to the government.
If the depositor falls in the highest tax slab of 30%, he will also have to pay additional slab tax while filing ITR. Additionally, if an FD is broken without thinking, both penalties and taxes bring down the actual returns below inflation, thereby reducing the purchasing power of the depositor.
According to financial advisors and wealth planners, the most effective way to protect large capital like Rs 50 lakh, maintain liquidity and get maximum returns. ‘Multi-Bank Diversification’ and ‘FD Laddering’ is a combination of:
1. Multi-Bank Diversification: Instead of keeping your amount of ₹50 lakh in one bank, divide it among 4 to 5 different strong and reliable banks (like top public sector banks, leading private banks and strong small finance banks). Keep the total amount including principal and interest in each bank in the range of ₹5 lakh to ₹7 lakh. By doing this your entire capital will be covered under the 100% sovereign insurance cover of DICGC.
2. FD Laddering Technique: Do not lock the entire amount in a single time frame. Divide it into different tenures:
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₹10 lakh: 1 year FD
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₹10 lakh: 2 year FD
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₹10 lakh: 3 year FD
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₹10 lakh: 4 year FD
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₹10 lakh: 5 year FD
The biggest advantage of this technique is that every year your FD matures, giving you a regular flow of cash. If you do not need the money at that time, you can renew that matured FD again for the next 5 years at the highest interest rate prevailing at that time. With this, the risk of interest rate fluctuations is completely eliminated and in case of any emergency, the money comes into hand without paying any penalty.
3. Joint Account and Family Planning: If you want to keep the number of banks less, you can open a joint account with family members by changing the ‘first name’ (eg husband + wife and wife + husband in the other account). As per banking rules, if the primary account holder is different, each account gets a separate insurance cover of ₹ 5 lakh under DICGC. By adopting these simple strategies, you can earn maximum interest while keeping your hard-earned money completely safe.