Fixed Deposits (FDs) are one of the most essential components of any investment portfolio in India. They give the comfort of guaranteed rate of returns and a fixed interest rate for which tenure is chosen. Yet, there can be some unplanned situations, and you may require withdrawing your FD money before it gets matured. This is where premature withdrawals take place, but you need to carefully consider the repercussions of such action.
Understanding Premature Withdrawal Penalties
Banks usually charge extra money for withdrawing FDs before the scheduled term to disincentivise such behavior. The amount of the penalty depends on the bank’s regulation and the type of the FD contract. Typically, it varies between 0.5% and 1% of the interest earned by the deposit.
Take for example an FD where the amount is Rs. 1 lakh for one year with a 6% rate of interest. If you withdraw the money before the end of six months, the bank will probably reduce the applicable interest rate to 5%. What does this mean? It means that not only are you going to lose the interest for the year, but also the compounded interest that you would have earned if the deposit had matured as it was supposed to.
The Real Costs of Withdrawing Before Maturity
Even though premature withdrawals are useful as they enable you to access your money, they have outcomes which go beyond the penalties that you pay. Here are some key factors to consider before making a decision:
Loss of potential interest: FDs earn from compound interest. In this situation, we miss the interest that would have gradually accrued along the course of the scheduled tenure. Now let’s look at the previous example. You not only deny yourself the last 0.5% interest for the year, but also the interest you would have earned on that sum of 0.5%. One could think that the effect might seem to be small, but it could accumulate over time.
Disruption of financial goals: Some FDs belong to particular financial goals such as a down payment on a house or child education. However, the earlier you take the money out, the more likely it is that you will have to postpone this plan or find another and probably more expensive way to finance it. For the sake of your long-term financial health, think twice before deflecting your FD before its maturity.
Options for Considering Before Retreat
Before resorting to a premature withdrawal, consider these options that could provide you with the necessary funds without disrupting your FD:
Loan against FD: Many banks provide loans where your FD is used as security. This means you can use the money without having to withdraw from the deposit and your interest still gets calculated. You only return the borrowed amount with interest, the FD is still there after maturity.
Partial withdrawal: Some banks permit partial withdrawal from Fixed Deposits. It can be an ideal way to get an urgent little amount of money if that is the case. There is no need to draw the whole amount at once, as the untouched corpus can also accumulate earning interest.
Liquid funds: In case you have issues with your access to the money, allocate some of your portfolio to liquid funds. These invest in highly liquid instruments like short-term government securities and treasury bills which can be easily redeemed when the need arises. Liquid funds provide some growth possibilities while serving as a reserve in case of any financial upsets.
Planning for Smooth Sailing
Do not engage in premature termination unless everything else fails. Here’s how you can minimize the need for it:
Plan your FDs strategically: Choose FD tenures that match your financial objectives. Don’t buy short-term FDs if you suspect you need the money in the short term. Correlate your FD maturity with your forthcoming needs and future goals. For example, if you are planning to get married in two years, a two-year FD will be suitable. Using different maturities, the FDs are structured in a ladder where some money matures regularly to meet short-term needs, but this does not affect the long-term goals.
Maintain an emergency fund: It is important to maintain a separate emergency fund in order to avoid accessing your FDs when any unexpected expenses appear. Try to accumulate 3-6 months’ worth of living expenses in your emergency fund. This is a good thing because it guarantees you some sort of safety in case of losing your job, medical emergency, or other unexpected situation.
Diversify your portfolio: Diversification of your portfolio is essential. Investigate possible investments having different risk-reward parameters to build a diversified portfolio. It could be a mixture of FDs, mutual funds, stocks, and bonds. The inclusion of some liquid funds which are easily accessible along with short-term debt instruments and long-term growth through FDs ensures you have the best of the two worlds.
Through gaining an insight into the repercussions of early withdrawal and by creating a sound financial plan, you can do an intelligent job managing FDs. Combine them to attain the best from them and stay on track with your long-term financial goals.
