Premature Fixed Deposit Withdrawal: Penalty & How to avoid it

72% of Indians don't have adequate emergency funds! Most people aren't ready to handle financial crunches, whether it is a medical emergency or sudden repair/maintenance. A go-to alternative to meet these emergencies is premature withdrawal from fixed deposits.

The average interest rate for fixed deposits is around 7% per annum, slightly above a normal savings account. Fixed deposits, also known as term deposits, are usually preferred due to their assured returns when compared to equities. However, due to limitations and penalties, people are apprehensive about prematurely closing their FD.

So, should you break your FD prematurely? How much of your returns are lost when you do? How do you even break an FD? Read on and find out.

Procedure for Premature Withdrawal of Fixed Deposit

Generally, the penalty charges range from 0.5% or 1% of the interest rate, based on the value of the FD being up to ₹5 lakh or more. The penalty is the amount charged by the bank when the depositor takes out the money from the bank before the date of maturity.

The fine is levied on the interest to be paid to the depositor. Very few banks offer zero penalty charges on premature withdrawal. However, the bank is liable to pay no interest if the FD is prematurely closed before completing seven days from the booking date.

You can apply for premature withdrawal in two ways, offline and online.

For the offline method, you need to visit the bank, submit the required documents, fill out the application form, visit the home branch and get the FD closed. 

For the online method, you must have booked the FD in online mode in the first place, and internet banking should be enabled for it. Your account should have a net banking facility. Customers can close their FD accounts prematurely using the banks' online web portal or app. The steps vary from one bank's portal to another, but the general procedure is similar.

If you need a lesser amount of funds than your fixed deposit, you can also save on the penalty by going for a partial withdrawal.

Tax-Saver fixed deposits do not allow any withdrawals, partial or otherwise. Most banks have a lock-in period of five years for Tax Saver Fixed Deposit.

Did you know that you need to maintain AMB (Average Monthly Balance) on the bank account linked to your Fixed Deposit?

FD Premature Withdrawal Penalty Calculator 

There are two cases that may arise in the case of a premature withdrawal of a fixed deposit. The difference between these two cases is the annual rate of interest provided by the two bank accounts; the Fixed Deposit account and the Savings Account. The scenario changes based on which account has the higher interest rate.

Case 1: FD interest rate is more than the Savings Account interest rate
Assuming that a customer has created an FD worth ₹1 lakh that provides 7% interest for 2 years. For the same scenario, let's assume that the prevalent savings account interest rate is 6.5%. She withdraws from the FD after completing 1 year. In one year, she would have earned around ₹7,000 in interest at the FD's rate of 7%. However, the new interest rate for the sake of premature withdrawal would be 6.5% – 0.5%= 6%. Therefore, the new rate will be 6%, and interest shall be paid at this rate instead of the previous 7%.

Case 2: Savings Account interest rate is higher than FD interest rate
Assuming that another customer has invested in an FD of Rs. 1 lakh at a rate of 6% for 2 years. Let us also believe that the interest rate for a normal savings bank account for 1 year at the time of the creation of the FD is 7%. The penalty rate for premature withdrawal shall be 0.5% of the effective interest rate in this case. The effective interest rate, in this situation, will be the lower of the two rates, and the lower rate shall be used for the calculation of the revised interest rate on the FD.

He withdraws from the FD after completing 1 year. For this period, he has accrued interest @ 6%. But the effective FD rate in the case of this premature withdrawal will be 6% – 0.5%= 5.5%. The holder of the FD account shall receive a reduced amount of interest after the reduction of the penalty.

Note: These are hypothetical scenarios only. The actual numbers and calculations may vary at the time of withdrawal. 

You can use online premature FD penalty calculators to gauge how big of a penalty you will pay, how much the interest will be lowered, and the disadvantages (if any) of withdrawing the money prematurely. In addition, you can analyse the returns you will get on withdrawal and how much you lose due to penalty so that you can either hold on to the FD amount or withdraw the amount partially. 

FD Withdrawal -Some Points To Ponder

FDs are considered a haven to park your money if you are a risk-averse investor. Breaking your FD prematurely may lead to some adverse consequences; you need to give thought to:

• Penalty
• Reduced interest,
• Reduction in the matured amount of FD.
• For retirees, premature withdrawal can stress one's retirement funds. Individuals can consider taking a loan on the FD.
• The documentation and filing processes are often cumbersome.

Ways To Avoid Making a Premature Withdrawal

1. Bank FD laddering: Laddering is buying multiple FDs maturing at different periods. Divide your lumpsum investment into smaller investments that will mature at different times, say, one year, two years, five years and so on.

2. Sweep-in facility: The facility enables you to transfer any sum over a preset amount specified by you from your savings account to a sweep-in deposit account. The interest rate varies according to the tenure of the deposit, from one year to five years. However, the preset amount mentioned above needs to be at least ₹25,000.

3. Avail of a loan against the FD: In many cases, most banks provide a loan against the FD. The amount that can be received as a loan can go as much as 90 % of the deposit account. The interest rate is usually 1-2% above the interest paid on the deposit.

The Bottom Line

Fixed deposits and their greater security as a result of low risk are often used by risk-averse investors. These include individuals with inflexible horizons, and a premature withdrawal can jeopardise their financial standing. Thus, proper research is necessary before taking a decision with such serious consequences. That being said, go for a premature withdrawal of your FD if it helps fulfil your requirements. When you need funds, breaking your FD can be a better option than other lending instruments based on your financial appetite.

Would you still go for premature withdrawal if you had other options?

Tell us in the comments section below.