A common practice for us is to put our savings; salary or money gifted to us either in a bank savings account or away in one corner of our cupboards- to be used for some exclusive purchase or emergency. What we tend to forget is that the sooner you start investing, the more time your money will have to grow. Remember compound interest that we did back in school? Well, it applies in real life too! Rs.100 that you invest today say, earns Rs.10 by next April 2015, and by April 2016 you not only get another Rs.10 on the original Rs.100, but also get another Re1 on the Rs.10 which was the profit for the first year. Simply put, the law of compounding returns says money invested creates more money. This is what I mean when I say let your money work for you!
Let me start with the basics of bank accounts. Current account and a Savings Account are the two basic accounts opened with a Bank.
A Current Account is generally used for easy liquidity with no limits on number of transactions from such an account and provides an overdraft facility. This account is used mainly for business purposes. The catch being that the bank pays no interest on the balance held in this current account.
A savings account meanwhile, is the most popular account in usage. Our credit cards are linked to it. The company we work for generally opens a savings account for us to credit our salary in it. This account also provides comfortable access to our funds. Generally, there are restrictions on transactions in such an account. A savings account with a bank generally provides return of 4% per annum (on the average monthly balances) payable once in six months.
From FY 2012-13, interest earned upto Rs 10,000 in saving bank accounts had been exempted from Tax under Sec 80TTA. It means that if you have an average balance of Rs 2.5 lakh in your savings account during a financial year, the interest would be tax free assuming a 4% interest rate. Some banks offer higher interest rates for higher balances maintained. The average balance to be maintained to avail the tax deduction therefore could vary. So, what should one do with the surplus funds in the Savings Account?
That’s where a Fixed Deposit or an FD in common parlance comes in.
You can open an FD linked to your existing savings account by visiting your branch or online comfortably from home or office. You have to choose the amount of the FD and the tenure. In case you have a surplus amount that you can spare for definite period, it will be better to put away funds in an FD for that period. The longer the period, better the returns. A Sweep Out facility allows customers to convert the surplus money in a Savings account above a certain limit into fixed deposits and a Sweep In will let you break the FD in case of insufficient balance in your saving account. Do remember that some banks impose a penalty for breaking an FD before its tenure comes to an end. In such a case, make sure that your FD tenure is planned.
An FD earns you better interest than a Savings account. One can earn as much as 7-10% on fixed deposits of varying tenure with banks. But, please remember, the interest income from fixed deposits is not exempted from income tax. You have the option to roll over the maturity proceeds of an FD into a new FD for a similar tenure. Say you had an amount of 3 Lakhs in your savings. Create an FD of Rs 50,000 in case you want to maintain easy cash availability of Rs 2.5 lakhs. You’ll be able to earn an interest of Rs 4,000 (on amount of 50,000) at the end of the year compared to leaving it in a Savings account which would have earned you only half of it at best. The more the money allocated to a FD, the better the total returns you’ll be able to earn even after tax. FDs are a good investment bet for people who want safe annual cash flows or want to secure funds available for a goal seen in near future.
But, FDs may not be the best investment tool from the tax perspective. Depending on the tax bracket you belong to, you should compare investing in an FD with a Liquid Mutual fund for yourself. There are also Corporate FDs one could invest in. Both Mutual funds and Corporate FDs will be explained in my subsequent articles.
Points to remember:
- Money invested creates more money by compounding.
- A Savings account provides liquidity to funds; at approx. 4% returns with Rs 10,000 tax exemption on interest earned.
- A Fixed Deposit should be created for any surplus funds in the Savings account for a defined tenure.
- An FD earns better returns after tax as compared to a Savings account.
- Be wise – Let your money work for you!