The most common type of account used to store funds is a savings account and FD. Its most popular attribute is the withdrawal flexibility. And when it comes to returns, fixed deposits are well-liked.
However, the majority of us are unaware of how the interest on these accounts is determined.
To better comprehend the returns on the money saved in savings accounts, let’s look at how banks compute Interest on Savings Accounts and FD.
The Reserve Bank of India’s 2010 rules state that the return on savings accounts is based on the daily outstanding balance. It entails that you receive interest on the money in your bank account at the end of each day.
The following is the formula for the same:
Interest on savings accounts is calculated as follows: Daily balance x Interest Rate x (Days/365)
Example: On Day 1, Mr. Deepak has Rs. 100,000 in his account. After seven days, he withdraws Rs. 50,000. and on the fourteenth day deposits Rs. 30,000. There are no transactions after that. Let’s take a look at the interest he has accrued for the month of January assuming the interest rate is 4%.
Calculation of FD Interest and in the event of an Early Withdrawal
In general, FD offer better interest rates than savings accounts. However, there is a lock-in time. A penalty is imposed on withdrawals made before the stipulated term, so you will only receive the money after a tiny portion of it has been taken out—usually between 0.5% and 1%.
Let’s use an illustration to better grasp this.
Ms. Ayushi deposited Rs. 100,000 in a fixed deposit for a year and received 8% p.a. income on her investment. The interest rate for six months is 6%. 0.5% is the premature withdrawal fee.
Case I: After a year, or at maturity, Ms. Ayushi withdraws.
Case II: Ms. Ayushi prematurely withdraws after six months.
If Ms. Ayushi successfully completes the F.D.’s term in the first scenario, she will get,
Interest: 80,000 x 100,000 x 8%
Total maturity value: Rs. 1,08,000 (100,000 plus 8,000).
As a result, Ms. Ayushi will get Rs. 1,08,000 at the end of a year.
In the second instance, Ms. Ayushi resigned before her one-year term was over. After six months, she stopped using her F.D. The interest will be determined differently in this situation.
She initially agreed to hold the deposit for a year, during which time the bank would pay her 8% interest, when she placed the deposit. However, because she is withdrawing sooner today, the bank will give her the amended interest rate that is valid for a fixed deposit of six months. In this instance, it is 6%.
The important thing to remember in this situation is that the bank would not pay her interest at the rate of 8% for a period of six months due to her early withdrawal. It will pay her interest applicable for a six month deposit period.
Additionally, the bank will impose a penalty for breaching the agreement, or early withdrawal, which in our example is 0.5%. Therefore, Ms. Ayushi will get an effective interest rate of 6% – 0.5% = 5.5%.
Viewing the computation
Interest over six months: 100,000 x 5.5 = 5000
Pre-Maturity Value: Rs. 1,05,500 for six months
Therefore, while calculating returns on a fixed deposit, more factors than only the interest rate should be taken into account. Planning and calculating the impact on your total return is particularly crucial in case you need to break the fixed deposit due to an early withdrawal.
Some banks provide early withdrawals without imposing any penalties.
However, even in those circumstances, you should examine the actual interest you would earn for an early withdrawal.
Charges(TDS) on Interest
The bank must deduct TDS at a rate of 10% from the interest generated on fixed deposits. There are two exceptions to the rule, though:
On interest generated on a savings account, no TDS must be taken.
If the interest earned on a fixed deposit is less than Rs. 10,000, no TDS must be withheld. This Rs. 10,000 limit is per bank. Therefore, a bank is obligated to deduct TDS @ 10% if it pays interest on a Fixed Deposit that is greater than Rs. 10,000 (Cumulative on all FD’s). However, if one bank pays cumulative interest of Rs. 8,000 for the entire year, while the other pays cumulative interest of Rs. 7,000 for the entire year, then the answer is no.Each bank must subtract TDS from any interest payments that are less than Rs. 10,000.
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