Fixed deposits are a great investment option for investors looking for low-risk avenues. With top issuers offering competitive interest rates, many invest in FDs to secure long-term growth. In FDs, the funds you deposit stay invested till the end of the predetermined tenor and generate a fixed interest.
Although not advisable, you can make a premature withdrawal of your FD amount. This helps you get quick access to funds when you require liquidity to address your needs. However, a premature withdrawal attracts penalties and other consequences that can hinder your financial growth. One of these consequences is its impact on your tax liability.
Read on to know the tax implications of the premature withdrawal of an FD and how to avoid it, along with the other consequences if you choose to go ahead.
Tax Implications of Premature Withdrawal of FD
The interest you earn on fixed deposits is subject to taxation. It gets added to your taxable income, and you pay tax as per your income tax slab rate. Moreover, you may have to pay TDS on fixed deposit interest, provided your interest earnings go above the limit.
As such, when you decide on the premature withdrawal of an FD, the tax implications may be felt in two steps. The first one is that the interest you earned till the date of withdrawal gets added to your taxable income. This may increase your overall tax liability.
The other tax implication is related to the TDS on fixed deposit interest. When you withdraw your FD before its fixed tenor ends, the issuer will recalculate the TDS based on your new interest rate. This is based on when you choose to withdraw your FD and what the FD rate is for that tenor. This too can fluctuate your overall tax liability.
Given this, it is safe to say that your tax liability will change when you choose to prematurely withdraw your FD. Since paying accurate taxes is crucial, you should consult your financial advisor before deciding on premature withdrawal.
Your financial advisor will help you understand the exact impact on your taxation, based on which you can make an informed and well-rounded decision. Moreover, remember that tax-saver FDs do not have the option of premature withdrawal.
In addition, FD issuers often have other guidelines in place in terms of when premature withdrawal is permissible. Make sure you are aware of them before going ahead.
Other Consequences of Premature Withdrawal of FDs
In addition to the impact on taxation, the premature withdrawal of FDs affects your earnings in other ways. Some of these impacts are:
New Interest Calculation
Generally, issuers levy a new interest rate when you make a premature withdrawal. Since it is a premature withdrawal, the tenor will be shorter than what you initially intended to invest. When it comes to fixed deposits, you generally earn a higher interest when the tenor is high and vice versa.
As such, your new interest will likely be lower than you were to earn. This means that your interest earnings will go down, too. The reduction in interest rate can be between 0.50% and 1%, which may seem small but can significantly impact your overall interest payout.
In addition to the reduction in the interest rate, FD issuers may charge a penalty amount when you withdraw your investment. This amount will depend on numerous things, such as when you make the premature withdrawal and the issuer’s policy.
These terms and conditions are generally mentioned in the FD agreement you sign while investing. Be sure to go through these carefully and compare them with other issuers to ensure that you make a cost-effective decision.
Dip in Overall Earnings
Sometimes, investors choose the route of premature withdrawal of FDs to invest the funds in a new deposit offering a higher interest rate. While you may assume that a higher interest rate means better returns, it may not be the case if a premature withdrawal is involved.
This is because a premature withdrawal is subject to a penalty and other charges. As such, there is a cost that you will bear. If these costs are higher than the potential increase in your earnings, you stand to face a dip or loss in your overall earnings.
You can use an FD calculator to understand the impact on your overall earnings. This tool will give you an estimate of your earnings, which you can compare against the costs. However, remember that the actual figures may vary slightly as different issuers have different calculation methods.
Alternatives to Premature Withdrawal of FDs
The premature withdrawal of an FD can have numerous impacts on your financial growth. Thankfully, there are a few ways to avoid withdrawing an FD prematurely and keep your financial growth intact. Here are some of the things you can do:
Lean on Your Emergency Fund
An emergency corpus is a necessity that everyone should build. In times of uncertainties and unexpected costs, this fund allows you to meet your financial obligations without liquidating your investments.
Ladder Your FDs
If you have goals for varying periods (in the short-term, mid-term, or long-term), you can ladder your FD to access liquidity while taking the steps towards financial growth. Moreover, if you do not need the funds when your laddered FD matures, you can simply re-invest the entire amount.
Get a Loan
Today, unsecured and secured loans are readily available. For secured loans, you can pledge your FD as collateral and get the funding you need. However, the amount is subject to your investment amount. If it is insufficient, you can opt for unsecured loans, which are available in just a few clicks.
Now that you know the tax implications and other consequences of choosing a premature withdrawal of an FD, remember to consider your finances holistically. Assess your income and savings and gauge future expenses when investing.
If you opt for a loan, see how its repayment will affect your future finances and ensure you can manage it comfortably. This way, you can invest to maximise your financial growth and repay, if needed, without much hassle.