How Does a Fixed Deposit (FD) Work?

A Fixed Deposit (FD), often referred to as a Certificate of Deposit (CD) in the United States, is a savings product offered by financial institutions. It allows individuals to deposit a lump sum for a predetermined period, known as the tenure, at a fixed interest rate. FDs are generally considered a low-risk option for growing savings.

Understanding Fixed Deposit Earnings

Fixed Deposits generate returns through interest, calculated based on the principal amount, interest rate, and tenure. The interest rate remains constant throughout the chosen term, offering a guaranteed return. For longer deposit terms, financial institutions may offer higher interest rates. Interest can be calculated using simple or compound methods. Compounding means earned interest is added to the principal, and subsequent interest is calculated on this new, larger sum, allowing the money to grow over time.

Depositors have two main options for interest payout: cumulative and non-cumulative. A cumulative Fixed Deposit reinvests earned interest into the principal, allowing it to compound until the maturity date. This option maximizes the growth of the initial deposit over the long term. In contrast, a non-cumulative Fixed Deposit provides regular interest payouts at chosen intervals, such as monthly, quarterly, semi-annually, or annually. This structure provides a steady income stream from the investment.

Interest earned from Fixed Deposits is considered taxable income at the federal and state levels. The Internal Revenue Service (IRS) classifies this interest as ordinary income, taxed at the depositor’s marginal income tax rate. Financial institutions report interest earnings to the IRS using Form 1099-INT. This form details the total interest earned during the tax year, which must be reported on the individual’s federal income tax return.

Setting Up a Fixed Deposit

Opening a Fixed Deposit account involves meeting eligibility criteria and providing documentation. Individuals must be at least 18 years old and a resident of the United States. Financial institutions set a minimum initial deposit amount, which can vary widely.

To complete the application, individuals need to provide:
Proof of identity (e.g., government-issued photo ID like a driver’s license or passport)
Proof of address (e.g., a recent utility bill or bank statement)
A Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN)
Details of an existing bank account for funding and receiving interest payments or the maturity payout.

Setting up a Fixed Deposit can be completed online or by visiting a financial institution’s branch. Online applications involve uploading digital copies of required documents and using electronic signatures. For in-person applications, physical documents must be presented. Once approved, the Fixed Deposit is funded, typically through a transfer from a linked checking or savings account.

Interacting with Your Fixed Deposit

After a Fixed Deposit is established, depositors have options for managing their investment. While FDs are designed to hold funds for a specific term, early withdrawals are possible but incur penalties, often a forfeiture of a portion of the accrued interest. These penalties vary by institution and can be substantial. Any early withdrawal penalty incurred can be deducted from taxable income.

Depositors can take a loan against their Fixed Deposit, using it as collateral. This allows access to funds without prematurely closing the FD and incurring a penalty. Financial institutions permit borrowing up to a certain percentage of the FD’s principal. The interest rate on such a loan is usually set slightly higher than the interest rate earned on the Fixed Deposit.

Upon maturity, depositors have choices regarding their funds. Many institutions offer automatic renewal, where the FD rolls over for another term at the prevailing interest rate. Alternatively, depositors can manually renew the FD, selecting a different term or adding funds. The final option is to receive the maturity payout, which includes the original principal amount plus all accrued interest. This payout is usually transferred electronically to a linked bank account or issued as a check.