What Is a Fixed Deposit and How Does It Work?

A Fixed Deposit (FD), commonly known as a Certificate of Deposit (CD) in the United States, is a widely used investment option. It provides a predictable way to grow savings over a set period. This financial instrument allows for a secure placement of funds, offering returns often more favorable than standard savings accounts.

Understanding Fixed Deposits

A Fixed Deposit involves placing a lump sum with a financial institution for a predetermined duration. Funds earn interest at a fixed rate agreed upon at deposit. The principal remains untouched until maturity, providing a known return regardless of market fluctuations.

This investment vehicle offers a higher interest yield than traditional savings accounts in exchange for limited access to funds. Investors commit their money for a specific time, benefiting from a guaranteed interest rate, making it suitable for those with defined financial goals.

Features of Fixed Deposits

A primary feature is the fixed interest rate, which is locked in for the entire duration of the deposit, ensuring stable and predictable earnings. Interest can be compounded and paid out at maturity, or disbursed periodically, such as monthly, quarterly, or annually, depending on the account terms.

Another characteristic is the fixed tenure, ranging from seven days to ten years. Early withdrawal is generally possible but typically incurs penalties, such as an interest rate reduction or a specific fee. FDs are low-risk investments, often backed by federal deposit insurance.

In the United States, CDs held at federally insured banks are protected by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per insured institution, for each ownership category. This insurance provides security against bank failure. Many FDs also offer a nomination facility, allowing depositors to designate a beneficiary.

Types of Fixed Deposits

Fixed Deposits come in various forms. One common distinction is between cumulative and non-cumulative FDs. With a cumulative FD, the interest earned is reinvested and compounded over the tenure, with the total principal and accumulated interest paid out at maturity. Non-cumulative FDs provide regular interest payouts during the deposit period.

For tax considerations in the United States, interest income earned from Fixed Deposits is generally fully taxable as ordinary income at both federal and state levels. This interest is typically reported to the Internal Revenue Service (IRS) on Form 1099-INT by the financial institution. However, if a CD is purchased within a tax-advantaged retirement account, such as an Individual Retirement Account (IRA) or a 401(k), the interest earnings may be tax-deferred until withdrawal.

Another type includes Fixed Deposits tailored for senior citizens, typically those aged 60 or older, who often receive a slightly higher interest rate than standard depositors. This preferential rate serves as an incentive for older individuals to secure their savings. Furthermore, FDs can be categorized by their duration as short-term or long-term, offering flexibility for various financial planning horizons.

Opening a Fixed Deposit

Opening a Fixed Deposit account involves a straightforward process, whether conducted online, through a mobile application, or by visiting a bank branch. Individuals will need to provide specific documentation to complete the application. This typically includes a valid government-issued identification, such as a driver’s license or passport, and proof of address like a recent utility bill.

Additionally, applicants usually need to provide their Social Security number or Individual Taxpayer Identification Number (ITIN) and details of the bank account from which the initial deposit will be funded. Before finalizing the deposit, it is prudent to consider the desired tenure for the funds, the preferred frequency of interest payout (cumulative or non-cumulative), and the principal amount to be deposited. These considerations help align the Fixed Deposit with individual financial objectives.