How is Interest on Recurring Deposit Calculated

03 Jul 2019

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How is interest on recurring deposit calculated

A recurring deposit is one of the best ways a small investor can invest funds and grow them. In a recurring deposit, a fixed amount of money is invested at a fixed duration for a fixed period of time. These installments all mature on the same date. Essentially, a recurring deposit is like having multiple fixed deposit investments, all of which mature on the same day.

You do not have to wait till a recurring deposit matures to find out the interest that you will earn on a recurring deposit. If you’re wondering how to calculate RD interest, then read this guide.

How to calculate recurring deposit interest using a calculator:

With the digital revolution in banking, the services offered by banks have undergone a sea change. It is no longer necessary to invest in a recurring deposit to find out how much you will earn on maturity. There are several banks that have a recurring deposit interest calculator on their website. This tool addresses how to calculate interest on RD account.

To calculate the RD account interest, you need to input the following:

  • Installment amount
  • Rate of interest
  • Period of investment

After putting in these details, you need to click submit and the calculator will show you the maturity amount. Using this calculator can help you find out the total interest you can earn on a recurring deposit instantly. It is very essential to use this calculator to find out the maturity amount and the interest as it can help you find out how much to invest if you’re raising funds for a particular goal. One important thing to remember is that banks compound interest quarterly on these deposits.

If you’re investing for a senior citizen, the rate of interest on such deposits is higher.

How to calculate RD interest manually?

If you’re wondering how to calculate compound interest for recurring deposit, you can use this formula:

M = P*(1+R/N)^Nt

M = Maturity amount.
P = Principal amount or the installment amount
R = Interest rate in decimal, convert interest rate into decimal by dividing it by 100
T = Time duration in months
t = Time duration in years
N= compounding frequency (since it is quarterly, it will be 4)

This formula is the formula for calculating compound interest. Banks generally compound interest quarterly on deposits. However, to calculate compound interest on recurring deposit, the balance at the beginning of the quarter is considered. So, if you open a recurring deposit between a quarter, simple interest is calculated for the months till a new quarter begins and from the new quarter, compound interest is calculated. This is why there may be a slight difference between manual calculation and the amount that a holder may receive on maturity.
Important points to remember about recurring deposit interest:

  • Interest on recurring deposit is taxable. This interest will be added to your taxable income and you will have to pay tax on it based on the slab you are in.
  • Your bank will deduct tax if the total interest on recurring deposit exceeds Rs. 10,000 in a year. You can submit Form 15G/15H declaring that your income won’t be in the taxable slab. On submission of this form, the bank won’t deduct tax on your recurring deposit income.
  • Senior citizens get a deduction on interest earned through recurring deposits under Section 80TTB up to Rs. 50,000. Section 80TTB gives a deduction on interest income from savings account interest, fixed deposit interest, recurring deposit interest etc.

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How does Fixed Deposit Work

A fixed deposit is one of the most popular investment avenues in India, particularly among risk-averse middle class investors. How does fixed deposit work? Let’s take a look.
How does a fixed deposit account work?
For that we have to understand that there are two parties involved here. One is the bank and the other is the customer. Banks need money, which they lend to borrowers from whom they charge interest. Banks obtain that money from its customers mainly through various accounts – current, savings etc.
One way of obtaining that money is through fixed deposits for which they offer certain rates of interest. The funds that they get is lent to borrowers for a slightly higher rate of interest. The difference between the interest rate on FDs and on loans is called the spread, which is the bank’s earnings.
How does fixed deposit work in India? If you have some spare cash and want to invest in fixed deposits, there are many options available for you. You can deposit money for periods ranging from a few days to a few years. Of course, the interest rates for shorter periods will be lower than those offered on fixed deposits of longer maturities. For example, if you want an FD for 30 days, the interest rate could be around 6 percent. If the deposit is for a year, the interest rate could be 7 percent.
The interest rates charged by different banks vary, so you might have to do a comparison to find the best rate. However, differences tend to be small. Smaller banks, like cooperative banks, may offer higher rates of interest than the large banks. However, you must remember that there is a direct correlation between risk and returns. High interest rates will always mean a higher level of risk.
Whether or not you choose to invest in a fixed deposit depends on how much returns you are satisfied with, and the amount of risk you are prepared to bear. Generally, returns on fixed deposits are lower than other investment avenues like equity, but the risks too are lower.
Advantages of fixed deposits
Hedge against inflation
Remember, the real value of your capital is being constantly eroded by inflation. If you have Rs 1 lakh and the inflation rate is 5 percent, the value of that Rs 1 lakh will become Rs 95,000 the next year. So depositing that cash in a fixed deposit will preserve the value of that cash.
Less risk
Fixed deposits are less risky than other investment avenues like equity. Moreover the Deposit Insurance and Credit Guarantee Corporation, a subsidiary of the Reserve Bank of India, insures FDs up to Rs 1 lakh (principal and interest), so your money is perfectly safe up to Rs 1 lakh.
Assured returns
Interest rates are fixed beforehand, so you don’t have to worry about what you’ll get when the FD matures
Now that we have explained what is a fixed deposit and how does it work, you can go ahead and open one. The process is straightforward and simple. If you have a savings account with your bank, you can open an FD with just a few clicks of your mouse. You can open an FD in other banks as well, but you have to open a savings account first. FDs are a good investment, and should be part of any investor’s portfolio.

How to open a fixed deposit account

Fixed deposits and the importance of having one
Time deposits or Term deposits are most commonly known as fixed deposits. Apart from mobilising funds from demand deposits like savings and current accounts, banks also resort to fixed deposits to raise funds. Fixed deposit, like the word suggests, have a fixed duration.
How to open a fixed deposit account
Now that we know what a fixed deposit (FD) is, let us see how we can open a fixed deposit account.
Fixed deposit accounts can be opened in the same way a savings account is opened.
One can either go to a branch of the bank and open a fixed deposit account after choosing the tenure or the person can use internet banking to open an account.
Banks these days offer the flexibility of automatically transferring money from the savings account to the fixed deposit account above a threshold limit as prescribed by the customer. It is called auto-sweep facility.
The key variable to choose in a fixed deposit account is the tenure. The interest rate is fixed by the bank.
Fixed deposits can be opened in banks where one does not have an account. However, here the documentation process is long, and one will need to provide all the details needed in a Know-Your-Customer (KYC) documentation.
There is no restriction in the number of fixed deposit accounts one can open.
Fixed deposits offer better interest rates as compared to a savings account but do not offer the customer the flexibility of withdrawing money as and when they want.
Duration of fixed deposits can vary from a few days to longer-term deposits which can go on for years. Interest changes with time. Higher the time period for which the money will be locked in higher will be the interest rates.
For example, a deposit for 7 days is generally given an interest of 3.5 per cent annualised while that for a year maybe around 6.5 per cent. The shorter period deposits will be more aligned to the savings deposits while the longer term deposits will be aligned to the bond market rates. The maximum period for which fixed deposits are offered is 10 years.
Banks offer higher interest rates for Fixed deposits to compensate for liquidity. Also, they seek longer-term deposits in order to lend the money to projects which have a long gestation period.
The longer-term deposits are more aligned to the bond markets where they compete with corporate and Non-Banking Finance Companies (NBFCs) for money.
Fixed deposits in the form of bonds or debentures are offered by corporate and NBFCs. Bond markets are increasingly getting a popular source of funds for corporate also as they do not have to go through the lengthy process of raising money through the banking system.
Mutual funds, especially the debt funds invest the money raised through the public in bonds. Thus fixed deposit rates of the banks have to be attractive enough to prevent depositors from running to mutual funds or the bonds offered by NBFCs.
In order to make the deal more attractive banks have over the years started offering frills with a Fixed Deposits account such as overdraft facility, zero cost credit cards, nomination facility, safe deposit lockers, internet banking among others.
Fixed Deposits earn higher interest than a Savings Account because the former gives them leg room to lend to people who need the money for roughly the same time limit. A one-year fixed deposit in a bank can allow the bank to lend money to a person who requires a personal loan for one-year period.

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