What is Fixed Deposit (FD) and How Does It Work, Types, Components, Benefits, Features, and Uses

What is Fixed Deposit (FD)?

A Fixed Deposit (FD) is a financial instrument offered by banks and certain non-banking financial companies (NBFCs) in India, where you deposit a lump sum of money for a fixed tenure at a predetermined interest rate. Unlike a regular savings account, where the interest rate can change, an FD locks in the interest rate at the time of deposit, giving you certainty about how much you will earn by the end of the term. You can open an FD with amounts as low as a few thousand rupees in most banks, making it accessible to a wide range of people.

In India, FDs are often considered one of the safest investment options. Since the principal amount is guaranteed and the interest is fixed, you face minimal risk. Furthermore, FDs are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) up to ₹5 lakhs per depositor per bank. This insurance cover ensures that even if the bank faces difficulties, your deposit up to that limit is protected.

Fixed Deposits are popular among individuals who prefer a conservative approach to saving and investing. Because the rate of interest is known in advance and because banks in India regularly offer attractive rates (often higher than those on savings accounts), many people salaried employees, retirees, and small-business owners choose FDs to park their surplus funds for short or medium-term needs.

How Does Fixed Deposit Work?

When you place money in an FD, you agree to keep it locked for a fixed period, which can range from seven days to ten years or even more, depending on the bank’s policies. You choose the tenure at the time of deposit: for example, one year, two years, or five years. The bank then credits interest on this deposit either on a monthly, quarterly, half-yearly, or annual basis, or it compounds the interest and pays it at maturity.

Interest Calculation: Banks calculate FD interest based on the simple interest or compound interest formula, depending on their payout option. In the case of simple interest, the calculation is straightforward:

Interest = (Principal x Rate x Time) / 100

For compound interest, the bank adds the interest to the principal at each compounding interval (for instance, quarterly), and then pays interest on that increased principal. Compound interest results in slightly higher earnings compared to simple interest.

Interest Payout Options:

• Cumulative FD: Interest is compounded at regular intervals (quarterly or half-yearly) and paid out along with the principal on maturity. This is a common choice if you do not need periodic interest income.
• Non-Cumulative FD: Interest is paid out at fixed intervals monthly, quarterly, or annually directly into your bank account or by issuing interest warrants. This option benefits individuals who need a steady income stream, such as pensioners.

Maturity and Premature Withdrawal: At the end of the chosen tenure, the FD matures, and you receive your principal plus the accrued interest. However, banks typically charge a penalty for premature withdrawal, which could be a reduction in the interest rate (e.g., from 6.50% to 6.00%) for the period the FD was active. Some banks allow you to withdraw a portion of the FD under special circumstances (such as medical emergencies), but the interest rate may be lower and subject to conditions.

Components of Fixed Deposit (FD)

• Principal Amount: This is the initial sum of money you deposit in the FD. You decide this amount at the time of opening the FD. Many banks have a minimum FD amount (often ₹1,000 or ₹5,000), but there is no fixed upper limit.
• Tenure (Duration): The tenure is how long you want to keep the money locked in the FD. It can range from a minimum of seven days to a maximum of ten years or more, although many banks cap it at ten years. Choosing the right tenure depends on your financial goals short-term needs might call for a 6 to 12-month FD, while long-term goals might be better served with a 3 to 5-year FD.
• Interest Rate: When you open an FD, the bank specifies an annual interest rate. This rate depends on factors like the tenure, the FD amount, and your categorization (for example, senior citizens often receive a higher rate). Rates can change over time, but once your FD is booked, the rate is locked in for the entire tenure.
• Interest Payout Option: You can choose how you want to receive the interest: either monthly, quarterly, half-yearly, annually, or at maturity (cumulative). If you opt for periodic payouts, you receive regular interest, but the overall effective rate might be slightly lower than a cumulative FD.
• Nominee Details: You can (and should) nominate someone to receive the FD proceeds in case of your death. Nomination is a simple but important step that simplifies the payout process for your family and ensures the funds go to the intended person.
• Tax Deduction at Source (TDS): If the interest earned on all your FDs in a year exceeds ₹40,000 (₹50,000 for senior citizens), the bank or NBFC deducts TDS at 10% (or 7.5% if you provide your Permanent Account Number (PAN) and the interest payment is over ₹50,000). If you do not provide a PAN and your interest exceeds ₹50,000 in a year, TDS is deducted at 20%.

Types of Fixed Deposits (FD)

• Regular Fixed Deposit: This is the standard FD product where you deposit a lump sum for a fixed tenor and receive interest either periodically or at maturity. The interest rate usually increases with a longer tenure.
• Cumulative Fixed Deposit: Here, the interest is compounded at regular intervals (usually quarterly) and paid out along with the principal at the end of the tenure. You do not receive any periodic payouts; instead, you benefit from compounding, which helps your investment grow more quickly.
• Non-Cumulative Fixed Deposit: In this type, you choose a specific frequency monthly, quarterly, half-yearly, or annually to receive interest payments directly into your bank account or through interest warrants. This is ideal for people who want a steady income flow, such as retirees.
• Tax-Saving Fixed Deposit: Under Section 80C of the Income Tax Act, 1961, you can invest in a tax-saving FD for a lock-in period of five years. The maximum deduction allowed under 80C is ₹1.5 lakh per financial year. Interest earned on tax-saving FDs is taxable as per your income slab, but the principal amount qualifies for deduction.
• Senior Citizen Fixed Deposit: Many banks offer higher interest rates usually 0.25% to 1% more for senior citizens (people aged 60 and above). These FDs also have flexible tenures and often allow penalty-free premature withdrawals under certain conditions, such as medical emergencies.
• Flexi or Sweep-in Fixed Deposit: This is a hybrid product combining a savings account with an FD. Funds above a certain threshold in your savings account are automatically swept into an FD to earn higher interest, and you can withdraw from the FD as needed. This ensures that excess cash earns better returns while maintaining liquidity.
• Recurring Deposit (RD) vs. FD: While both offer fixed interest rates, an RD allows you to deposit a fixed amount every month, whereas an FD requires a lump sum. They are structurally different; hence, RDs are not usually categorized strictly under “FD,” but banks often market them alongside FDs.

Feature of Fixed Deposit (FD)

• Safety of Principal: FDs are among the safest investment options, especially when placed with scheduled commercial banks. As mentioned earlier, deposits up to ₹5 lakh per depositor per bank are insured by the DICGC, reducing risk.
• Guaranteed Returns: Because the interest rate is fixed at the time of booking, you know in advance exactly how much you will earn. This predictability makes FDs suitable for conservative investors and for financial planning of specific goals like children’s education or wedding expenses.
• Flexible Tenure: You have the flexibility to choose a tenure that aligns with your financial goal, ranging from as short as 7 days to as long as 10 years. This allows you to match the FD to short-term needs (e.g., a 6-month FD) or long-term objectives (e.g., a 3-year FD).
• Liquidity and Loans: Although an FD is meant to be a “fixed” deposit, most banks allow premature withdrawals after a lock-in period (usually 7 days or 1 month, depending on the bank). However, penalties on interest apply. Alternatively, you can take a loan or overdraft against your FD (typically up to 75%-90% of the FD value), which provides liquidity without breaking the FD prematurely.
• Nomination Facility: You can nominate a family member or any beneficiary. In the event of your demise, the nominee can claim the FD proceeds without undergoing lengthy legal procedures.
• Joint Account Option: Many banks allow joint FDs, where two or more people such as spouses or parents and children can jointly open an FD. In case of the death of one holder, the surviving nominee(s) can continue or claim the FD.
• Automatic Renewal: If you do not instruct the bank otherwise before the maturity date, the FD may automatically renew for the same tenure at the prevailing rate. This feature prevents a lapse in investment but may earn a lower interest rate than your original FD if rates have dropped.

Benefits of Fixed Deposit (FD)

• Higher Interest Rates Than Savings Accounts: Banks typically offer FD rates from around 5% to 7.5% per annum, which is significantly higher than the 3.0%-4.0% usually offered on savings accounts. Senior citizen FDs may fetch 6.0%-8.0% or even slightly higher, depending on the bank.
• Low Risk: Since the principal is safe (especially within the ₹5 lakh insurance limit), FDs are virtually risk-free. You are not exposed to market fluctuations as you would be with stocks or mutual funds.
• Predictable Income: For those who need a reliable income stream such as retired individuals opting for a non-cumulative FD with monthly or quarterly payouts can provide stable cash flow.
• Easy to Open and Manage: Bank branches and online banking platforms make it simple to open an FD. You can even start an FD through mobile banking or internet banking, without visiting the branch.
• Loan Against FD: Instead of prematurely breaking the FD, you can avail a loan against the FD at a relatively low interest rate, usually 1%-2% above the FD rate. This allows you to meet urgent cash requirements without affecting your investment.
• Tax Benefits (for Tax-Saving FD): A tax-saving FD with a 5-year lock-in under Section 80C can reduce your taxable income up to ₹1.5 lakh in a financial year. Though the interest is taxable, the principal portion is exempt.
• Peace of Mind: The simplicity and security of an FD along with guaranteed returns give peace of mind to risk-averse investors. You do not need to monitor market movements or worry about volatility.

Uses of Fixed Deposit (FD)

• Emergency Fund: An FD can be part of your emergency fund strategy. Although an emergency fund is ideally kept in a highly liquid form, you can create a “short-term FD” that matures soon, ensuring you earn higher interest than a savings account while still having access to money within a few months.
• Child’s Education or Wedding Fund: FDs are often used to save for predictable future expenses such as a child’s college fees or a wedding. By choosing a FD that matures around the time you need the funds, you can secure a known return on your investment.
• Retirement Income: Senior citizens or pre-retirees frequently ladder multiple FDs with staggered maturities so that they get a regular flow of funds to meet living expenses post-retirement.
• Home Renovation or Car Purchase: If you plan a big purchase a year or two down the line, parking a lump sum in an FD can help you both save and earn decent returns without risking the principal.
• Tax Planning: By investing up to ₹1.5 lakh in a Tax-Saving FD, you can reduce your taxable income under Section 80C, while the FD itself matures in five years, helping you plan medium-term goals.
• Corporate and Business Purposes: Small-business owners sometimes keep surplus working capital in FDs to earn higher interest until they need to use that money. It also helps in maintaining liquidity ratios and improving credit scores when loan applications are evaluated.
• Fixed-Income Portfolio Allocation: Investors who want to balance risk in their portfolio might allocate a portion to FDs to counterbalance more volatile investments like equities or mutual funds.

Who Should Invest in an FD?

• Risk-Averse Investors: If you are uncomfortable with market volatility or lack experience in stocks and mutual funds, an FD provides a safe avenue to earn steady returns.
• Retirees and Senior Citizens: Those who are living on fixed incomes often use non-cumulative FDs to receive monthly or quarterly interest, helping them with monthly expenses. Senior citizens also benefit from higher interest rates offered exclusively to them.
• Short to Medium-Term Savers: If you have financial goals falling within a 1 to 3-year timeline such as vacation expenses, loan repayment, or home renovation an FD can deliver a predictable return without the risk of stock market fluctuations.
• Conservative Portfolio Managers: Investors who wish to maintain a balanced portfolio by adding a low-risk component can put some of their funds into FDs while allocating the rest to more aggressive assets like equity mutual funds.
• Those Needing Liquidity with Safety: If you need an investment that provides liquidity (through loan against FD or premature withdrawal) but still ensures the safety of the principal, an FD can be a good choice.
• Earners Seeking Tax Deductions: Salaried taxpayers in higher tax brackets can benefit from Tax-Saving FDs, which allow a deduction of up to ₹1.5 lakh under Section 80C. If you want a simple way to reduce your tax liability, this FD can be useful.

Taxability on Fixed Deposit in India

Interest Income Taxed as per Slab:

Any interest earned on an FD is added to your total income and taxed at your applicable income tax slab rate. There is no special concessional rate for FD interest; for example, if you fall in the 30% tax bracket (plus cess), the FD interest will also be taxed at 30%.

Tax Deduction at Source (TDS):

• If your total interest income from FDs across all banks in a financial year exceeds ₹40,000 (₹50,000 if you are a senior citizen), the bank will deduct TDS at 10%.
• If you do not furnish your PAN to the bank, and your interest income is above ₹50,000 in a year, TDS is deducted at 20%.
• If your total interest is below ₹40,000 (₹50,000 for senior citizens), the bank does not deduct TDS, but you still must declare this interest income in your Income Tax Return (ITR).

Form 15G/15H:

If you are a resident individual or HUF whose total income is below the taxable limit, you can submit Form 15G (or Form 15H if you are a senior citizen) to the bank to request that no TDS be deducted on your FD interest.

Tax-Saving FD:

Even though a tax-saving FD gives you a deduction under Section 80C for the principal amount (up to ₹1.5 lakh), the interest earned is fully taxable in the year it is received, at your slab rate.

Capital Gains vs. Interest Income:

FD interest is treated as income from other sources, not as capital gains. Hence, it is taxed at your regular slab rate rather than at the special rates that might apply to capital gains.

How to Apply for a Fixed Deposit (FD)?

Choose the Bank or NBFC:

Research and compare interest rates, tenure options, and special FD schemes (such as tax-saving or senior citizen FD). Consider the bank’s reputation, online convenience, and any digital offers.

Decide the Tenure and Amount:

Based on your financial goal whether it is short-term, medium-term, or long-term select a tenure (e.g., 6 months, 1 year, 3 years). Decide how much money you want to lock in. Keep in mind your liquidity needs and the penalty that may apply for premature withdrawal.

Gather KYC Documents:

You generally need a PAN card, Aadhaar card (or other identity proof such as passport or voter ID), and an address proof (utility bills, driving license, or Aadhaar) to open an FD. If you are an existing customer of the bank, the bank may already have your KYC details on file, making this step quicker.

Visit the Branch or Apply Online:

• Offline: Go to the bank’s nearest branch, fill out the FD application form, submit KYC documents, and deposit the cheque or cash for the FD amount. Provide nomination details to ensure a smooth claim process for your nominee, if necessary.
• Online: Log in to your bank’s internet banking portal or mobile banking app. Navigate to the “Fixed Deposit” section, choose the FD type (cumulative, non-cumulative, tax-saving, senior citizen), enter the amount and tenure, select the interest payout option, and confirm. The FD account number or reference is generated instantly, and the bank debits your savings or current account for the FD amount.

Make the Payment:

For an offline FD, you hand over a cheque or cash at the branch counter. For an online FD, you need sufficient balance in your linked savings or current account, which the bank will debit automatically for the FD amount.

Receive Confirmation:

The bank issues an FD receipt instantly (offline) or a digital FD certificate (online) that mentions the FD account number, principal amount, interest rate, tenure, maturity date, and nominee details. Keep this carefully online users can generally download a PDF copy.

Track Your FD:

You can monitor your FD view the interest accrued, check maturity date, or opt for automatic renewal via your bank’s internet banking portal or passbook (if you opened it at a branch).

Maturity and Renewal:

When the FD matures, you will receive the principal plus interest in your linked savings account. If you have opted for automatic renewal, the FD will roll over for the same tenure at the prevailing interest rate, unless you instruct the bank otherwise at least a few days before maturity.