How to calculate returns on FDs?

Fixed Deposits or FDs are one of the most popular savings instruments in India. Investment in FD can be done for a few weeks to few years at a fixed interest rate. In this article, we will look at the two types of FDs, viz, interest payment and reinvestment. The article highlights the difference between these two and the calculation of interest with and without TDS for these two types of FD.

Interest Payout vs Reinvestment Option

Below is the table that points out the differences between the two options available under FDs.

Point of DifferenceInterest Payout OptionReinvestment Option
Interest PaymentInterest is paid out every month or quarterInterest is paid along with the principal at the time of maturity
SuitabilitySuitable for investors who want regular income like retireesSuitable for investors who are in no need of regular income
ReinvestmentInterest is not reinvested. It is paid out to the investor monthly or quarterlyInterest is reinvested into the FD along with the principal amount and paid only at maturity
Interest CalculationInterest is calculated normally using the simple interest formulaInterest is calculated using compounded interest formula. Interest is compounded.
TaxInterest earned quarterly or monthly will be taxable at the rate of 10%. However, the maturity amount is tax free.Interest though earned at the time of maturity, will be taxed yearly at the rate of 10%. However, the maturity amount is tax free.

Calculation of Interest on FD

Interest rates of FDs are currently around 6-8%. Furthermore the longer the duration more will be the interest rate of an FD. If you are in no need of regular income, instead of opting for an interest payout, which pays you interest every month or quarter, you can choose a reinvestment scheme. You can reinvest the interest earned on an FD hence earning higher interest.

Example 1

Interest Payment Option

Rs 10,00,000 FD invested for 3 years at the interest rate of 6.75% per annum. Simple interest is used to calculate the monthly interest payment. Below is the maturity value of the FD without TDS and income tax.

 

Reinvestment Option

Let’s say the Rs 10,00,000 FD is invested at 6.75% per annum under the reinvestment scheme. The monthly interest would’ve been reinvested in the FD at the same rate. The interest payment is calculated on a compounding basis. Below is the maturity value of the FD without TDS and income tax.

 

Example 2

Interest Payment Option

Rs 10,00,000 FD invested for 3 years at the interest rate of 6.75% per annum. Simple interest is used to calculate the monthly interest payment. Below is the maturity value of the FD with 10% TDS and 30% income tax.

 

Reinvestment Option

Let’s say the Rs 10,00,000 FD is invested at 6.75% per annum under the reinvestment scheme. The monthly interest would’ve been reinvested in the FD at the same rate. The interest payment is calculated on a compounding basis. Below is the maturity value of the FD with 10% TDS and 30% income tax.

 

If you are looking for monthly income then interest payment option suits you better. Else, the reinvestment plan is the best choice because interest is compounded. The effective rate for interest in reinvestment options differs by 42 basis points in contrast to interest payment option. That is a difference of Rs 13,822. This might not seem a lot but as the tenure of the FD increases so will the gap between the maturity amounts of these two options will increase. What Einstein said is certainly noteworthy that compound interest is the eighth wonder of the world. It surely does wonders with the money invested.

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