You must have bank fixed deposits with your bank as bank fixed deposits are amongst the safest avenue of investments. But, have you ever checked, exact how much return you would get when those matures. We often know the fixed rate of interest per annum, say 8% or 9%, but you may not know how banks calculate your interest on the principal and deduct TDS thereon.  In this article, you would see the exact picture how your bank follows the practice on calculation of your interest and deduction of TDS onto.
 
There are two main categories of deposits that banks usually offer; one is payout and other in cumulative options. In case of payout, banks retain the principal amount with them and return whatever interest you earn, on a periodic basis such as monthly, quarterly, semi-annually and annually is credited into your saving account and you get principal back at maturity. In Cumulative option, banks re-invest your interest earnings at the same interest rate in the same fixed deposit on your behalf and hence, increased amount becomes the new principal for the next period. 
How Cumulative option works?  
Cumulative fixed deposits, are compounded, often quarterly which means, if you deposit Rs100 in a fixed deposit, and the interest rate is 8% pa, you would get 2% each quarter and earn Rs 2 as the interest amount. The bank would re-invest this amount on your behalf, in the same fixed deposit and your principal would become Rs 102 for the next quarter. Now, you would get 2% interest on that principal amount. So effectively, you would earn an annual interest rate of 8.25% pa.
How TDS Calculated and Deducted?
TDS on fixed deposits is currently deducted if your interest earned on all fixed deposits across all banks and branches in one year is more than Rs10,000 at  the rate of 10% plus 3% education cess thereon which makes total deduction to 10.3%. Therefore, if you earn an interest of Rs 15,000 annually, your TDS deduction would be in the tune of Rs1,545.
What Some banks follow the practice?
Some banks deduct TDS on each payout, which effectively reduces the amount that the bank re-invests on your behalf after each payout period. As the re-investment amount reduces, the effective yield reduces, to a large extent.  Before, going into practices in various banks, we should know what the RBI’s circular actually says;
“Tax shall be deducted at sources on accrual of interest at the end of financial  year or at periodic  intervals as per practice of the bank or as per the depositor’s / payee’s requirement or on maturity or on encashment of time deposits; whichever takes place earlier; whenever the aggregate of amounts of interest income credited or paid or likely to be credited or paid during the financial year by the banks exceeds the limits specified.”
It means RBI has given full liberty to all across banks to follow either any option for deduction of TDS on fixed deposit such as end of the financial  year or at periodic intervals or as per practice of the bank or depositor’s/ bank’s requirement or on maturity or on encashment. Some banks are taking advantage to increase their own profitability through this route. These banks are calculating their advantage in ‘banks’ practices’ and the customer does not know about the ‘depositor’s requirement’ clause.  In their bank practices, they deduct TDS on each payout, which effectively reducing your returns as outlined above.
 
How This Saps Your Returns?
We have made a comparison of the extent of the effect that TDS can have on your returns. The following illustration shows that how the effective rate of interest for an 8% fixed deposit comes down to 7.39% if the bank deducts TDS quarterly.  Let’s say you have invested Rs1 lakh, if the bank deducts TDS annually, the interest earned at the end of year is  Rs7,419 ,the TDS is Rs 824, and the annualized effective yield works out to 7.419 per cent, So, the net amount paid at maturity is Rs 1,07,419.
If the TDS is applied twice in a year, the interest earned is Rs7,404, the TDS is Rs823 and the annualized effective yield works out to 7.40 percent. So, the net amount paid at maturity is Rs 1,07,404.
If the bank deducts TDS every quarter, the interest earned at the end of the year is Rs7,397 ,the TDS is Rs 822 and the annualized effective yield  works out to 7.39 percent So, the net amount paid at maturity is Rs 1,07397. The bank stands to benefit by more frequent TDS deduction because the amount it requires to re-invest on your behalf becomes lesser and, thus, it requires paying you a less interest amount. 
What you should check while investing?
Before you lock into an FD, check what is the procedure followed by the bank for deducting TDS. In case it deducts annually, you are safe. But if it deducts TDS quarterly or semi-annually, you may want to calculate your loss and compare with other banks that deduct TDS annually. In that case, you might want to switch your fixed deposits even if the interest rate you are getting is lower. It may still give you a higher return taking quarterly TDS into consideration with your current bank.
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Suresh Kumar Narula

SEBI Investment Advisor, Founder & Principal Financial Planner at Prudent Financial Planners
Suresh K Narula is founder and Principal Financial Planner at Prudent Financial Planners. He has earned the professional CERITIFIED FINANCIAL PLANNER and got registered with SEBI as Investment Advisor. He writes on personal and financial planning articles and got published in Dainik Bhaskar, Business Bhaskar and The Financial Planner's Guild, India. He is also a member of Financial Planner's Guild India ( An association of practicing SEBI registered Investment advisers) to create awareness about Financial Planning in general public, promote professional excellence and ensure high quality practice standards. Suresh received his an M.com from Himachal Pardesh University and an MFC from Punjab University, Chandigarh. He can be reached at info@prudentfp.in
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