Recurring deposits – Start now to Gain from High Interest Rates?

If you are looking for investing your money in debt instruments, it’s the right time to do so. RBI (Reserve Bank of India) on March 9, 2012 has reduced CRR rates by 0.75%. This means banks would have more money to lend and so loan rates are expected to go down and so are fixed deposit rates.

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To benefit from this high interest rate, you can lock in your lump sum money in Fixed deposits. But if you don’t have a lump sum and still want to take the advantage of high prevailing interest rates – Recurring Deposit (RD) is the solution.

What is Recurring Deposit?

Recurring deposits are similar to systematic investment plans and fixed deposits. You make a fixed investment every month, which earns a certain rate of interest. At the end of the tenure, you get a lump sum, which is equal to the total amount invested, along with the interest earned on it.

Recurring Deposit – the Details:

Recurring deposit can be opened both with banks and your local post office. The minimum investment is Rs 100 at most banks, while post offices accept even an initial amount of Rs 10. Some banks have an upper limit of Rs 15 lakh and the tenure varies from six months to 10 years. Senior citizens are eligible for a higher rate of interest, usually 0.5% more than that for other investors.

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Typically, a bank insists that you open a savings account with it before opting for a recurring deposit. This is because your monthly installments will be routed through this account.

Interest Rate for Recurring deposit:

The interest rates for both Recurring Deposit and Fixed deposit is similar. Below is the list of best Recurring deposit schemes available for different tenures.

* Maturity Value is calculated as the sum you would get after the specified tenure at the given interest rates, if you invest Rs. 5,000 every month

Who can open a Recurring Deposit?

Anyone can open a recurring deposit with a bank or post office, including a Hindu Undivided Family (HUF).

NRIs cannot open a recurring deposit in a post office but they can set up an account under their NRE accounts with banks or other financial institutions.

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Words of Caution:

Commit a monthly installment you can pay comfortably, as missing of an installment may lead to a default, which could result in a penalty. The penalty will depend on the monthly installment and the number of days by which you have delayed the payment. It will be deducted from the interest that has been accrued on the deposit till then. If you default frequently, your account could even be shut down.

Each bank has its own policy on dealing with defaulters. For instance, if you default for five consecutive months, HDFC Bank will send you a notice, and if you fail to pay for the sixth month too, the bank will shut down your account. The post office excuses a defaulter four times and also extends the payment period to two months, after which it will axe the account. DCB Bank does not charge a penalty, but it will consider an account inactive if you do not deposit any money for two years. A holder of such an account will be sent a notice, after which the bank may take a call on closing it.

You cannot opt for partial installments. For instance, if you pay Rs 2,000 a month, you cannot break this up in two installments of Rs 1,000 each. Also, you cannot pay more than the fixed amount every month.  Even if a bank allows you to deposit more, you will not earn any interest on the additional amount.  Another drawback is that once the tenure is fixed, you cannot change it.

Premature withdrawal of Recurring deposits:

If you are in an urgent need of money midway, banks allow premature withdrawal of the RD. You can withdraw it prematurely after one year in case of the post office and three years for most banks. However, you might lose out on the interest by 1-1.5 per cent. A better option would be to take a loan or an overdraft against the balance of your RD. While Canara Bank offers loan against the RD balance, State Bank of India (SBI), gives both loan or overdraft against a recurring deposit, which could be up to 90 per cent of the RD balance. It’s a win-win option for you as, first, your RD keeps earning interest at the original rate and, second, you get a loan or an overdraft at a lower rate compared to other options, such as a personal loan.

Tax implications of Recurring deposits:

Unlike fixed deposits, where banks deduct TDS (tax deducted on source) on the interest earned, there is no such deduction in the case of an RD. The tax liability rests with the depositor on his overall annual income through all sources. In case of minors who have a joint account with their parents, the interest accrued will be clubbed with the income of the parent whose total income is higher.

Does Recurring Deposit suit all?

For people with fluctuating income patterns, an RD may not be the ideal product. As stated above in an RD, if you miss a payment, you have to pay a penalty. If you have an irregular income pattern, you may take a look at the bank sweep-out account, under which whenever you have surpluses above a prescribed level, the bank automatically books an FD of the surplus amount.