Fixed deposits, or FDs, have traditionally been a popular investment option for Indians. In addition to secured returns, the bank also provides tax-saving term deposits (FDs) with a minimum tenure of five years, the annual principle of which is eligible for a tax exemption under Section 80C of the Income Tax Act of 1961 up to a maximum of Rs.1.5 lakh.
If, as a potential investor, you are looking for the best fixed deposit plans , then it is imperative to know more about the interest calculation FDs and the TDS applicable to them. It will help you in making an informed decision.
How are interest rates calculated on FDs?
Simple Interest and Compound Interest are the formulas used to determine interest on a fixed deposit. Depending on the deposit size and duration, banks may employ either option.
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Simple interest
The computation of simple interest (SI) involves multiplying the principal by the interest rate and the time period, then dividing it by 100, which then reflects (P * R * T/100).
Where
P = Principal, R = Interest rate, and T = tenure (in years)
For example,
Now, you can figure out the interest if you invest Rs. 10,000 at 8% each year for five years.
Step 1: 10,000 * 8 * 5 = Rs. 4,00,000 Indian rupees.
Step 2: Subtract that amount from 100. You receive Rs. 4,000 INR.
So, over a period of five years, you will earn Rs. 4,000 in interest.
As a result, if you put Rs. 10,000 into a fixed deposit earning 8% annual simple interest, you will receive Rs. 14,000 at the conclusion of the five-year term.
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Compound interest
The calculation of compound interest is not so simple. The reason being the interest accrued here is on both the principal and the deposited interest amount.
For instance, let’s say a bank gives 8% yearly interest on a 5-year deposit with annual compounding. As a result, if you choose to invest INR 10,000, the interest can be calculated as follows:
- Year 1
For the first year, we start using the straightforward interest technique.
Interest= 10,000* 8* 1/100 = Rs. 800
So, 800 INR worth of interest is earned in the first year.
Now, this interest will be added to the principal amount. As a result, the second-year principal is now Rs. 10,800. And then, the interest is calculated on this new principal amount.
- Year 2
Now, as you make 8% on INR 10,800 in the second year,
Interest= 10,800x8x1/100 = INR 864
You receive interest of INR 864, and this is once more re-added to the principal. Now your deposit is 11,644 Indian rupees.
Similarly, we can determine the CI for the following three years. However, some financial institutions offer compound interest monthly, quarterly, and half-year.
Compound Interest (CI) is calculated as P (1 + I/100) n – 1.
Where P stands for principal, n for the number of years, and I represents the periodic interest rate.
As a result, in the previous example, you gain
CI= 10,000 {(1+8/100)5 – 1} = Rs. 4,693
The total amount will be equal to Rs. 14,693
Hence, one should always ask their financial institution about the interest calculation method they use and choose the best-fixed deposit plans accordingly.
TDS calculation on fixed deposits
Below are the different TDS rates that apply to various customers:
- For residents of India, the TDS on the interest earned on fixed deposits by Indian residents will be 10% in the fiscal year 2023–2024.
- TDS of 30% plus any surcharges and taxes must be paid for NRE deposits on interest earned from fixed deposits.
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Let’s look at the following example to understand TDS calculation better:
If Rahul has two fixed deposits for Rs.1 lakh each and receives interest at a rate of 10% p.a. for 4 years, he will receive Rs.20,000 in interest from both FDs combined. In these circumstances, 10% of the entire interest income will be taxed as TDS, and he will therefore be required to pay TDS of Rs. 2000.
However, one can direct the financial institution not to deduct the TDS by submitting forms 15G and 15H.
Conclusion
To sum it up, as a potential investor, you need to be aware of all the aspects of your investments. So, calculating the return in advance will help you to decide on the investment period and plan accordingly. Knowing the TDS and how to manage it will also help you maximise your savings without breaking any laws.
