The most common type of account used to store funds is a savings account. Its most popular attribute is withdrawal flexibility. And when it comes to returns, fixed deposits are well-liked.
However, the majority of us are unaware of how the interest on these accounts is determined.
To better comprehend the returns on the money saved in savings accounts, let’s look at how banks compute Interest on Savings Accounts and Fixed Deposits.
How does a Bank compute interest on a Savings Account?
The Reserve Bank of India’s 2010 rules stipulate that the interest rate on savings accounts is calculated based on the daily outstanding balance. It entails receiving interest on the money in your bank account at the end of each day.
The following is the formula for the same:
Interest on savings account= Daily balance x Rate of interest x (Number of days/365)
Let’s use an illustration to try to better grasp it.
Let’s say that on Day 1, Mr. X has Rs. 100,000 in his account. After seven days, he withdraws Rs. 50,000, and on the fourteenth day deposits Rs. 20,000. There are no transactions after that. Let’s look at the interest he has accrued for January, assuming the interest rate is 5%.
| Sl. No. | Date | Opening Balance | Deposit | Withdrawal | Outstanding |
| 1 | 01.01.2022 | 100,000 | – | – | 100,000 |
| 2 | 07.01.2022 | 1,00,000 | – | 50,000 | 50,000 |
| 3 | 14.01.2022 | 50,000 | 30,000 | – | 80,000 |
| 4 | 31.01.2022 | 80,000 | – | – | 80,000 |
The interest will be computed in this case as follows:
The outstanding balance from January 1, 2022, to January 6, 2022, was Rs. 100,000. The interest will thus be computed on Rs. 100.000 for a period of 7 days, which is,
100,000*5/100*7/365= 95.89
The outstanding balance from 7.1.2022 to 14.1.2022 was Rs. 50,000, and interest will be computed on that amount for a period of 7 days.
50,000*5/100*7/365= 47.94
The outstanding sum from 14.1.2022 to 31.1.2022 was Rs. 80,000, and the interest for the subsequent 18 days will be,
80,000*5/100*18/365= 197.26
Consequently, the total interest earned in January will be,
95.89+47.94+197.26= 341.09
For the month of January, interest was earned.
| Sl. No. | Outstanding Balance | No. of Days | Computation of Interest | Interest Earned |
| 1 | 100,000 | 7 | 100,000*5/100*7/365= 95.89 | 95.89 |
| 2 | 50,000 | 7 | 50,000*5/100*7/365= 47.94 | 47.94 |
| 3 | 80,000 | 18 | 80,000*5/100*18/365= 197.26 | 197.26 |
| 4 | Total Interest Earned | 341.09 | ||
Even though the interest is based on the daily balance amount, depending on your bank’s policy, it may be charged to your account every six months or every three months.
Calculation of Fixed Deposit Interest and in the event of an Early Withdrawal
In general, fixed deposits offer better interest rates than savings accounts. However, there is a lock-in time. You will receive the money after a little proportion has been taken out, often between 0.5 percent and 1 percent, if you withdraw before the stipulated duration without paying a penalty.
The following is the interest calculation formula:
Interest equals Principal*Interest Rate.
Let’s use an illustration to better grasp this.
Ms. Y deposited Rs. 100,000 into a fixed deposit for a year and earned an interest rate of 8% per annum. The interest rate for a six-month period is 6%. A 0.5 percent premature withdrawal fee is charged.
Case I: After a year, or at maturity, Ms. Y withdraws.
Case II: Ms. Y prematurely withdraws after six months.
In the first case, where Ms. Y completes the tenure of the F.D., she will earn,
Interest: 100,000 times 8% equals 8000.
Total Maturity value: 100,000+8000= Rs. 1,08,000
Thus, at the end of 1 year, Ms. Y will receive Rs. 1,08,000.
In the second instance, Ms. Y resigned before her one-year term was over. After six months, she stopped using her F.D. The interest will be determined differently in this situation.
She initially agreed to hold the deposit for a year, during which time the bank would pay her 8% interest on the deposit. However, because she is withdrawing the money sooner today, the bank will apply the amended interest rate, which is valid for a fixed deposit of six months. In this instance, it is 6%. The important thing to remember in this situation is that the bank would not pay her interest at the 8% rate for a period of 6 months due to her early withdrawal. She’ll receive interest based on a six-month deposit term.
Additionally, the bank will impose a fee for breaching the agreement, or early withdrawal, which in our example is 0.5 percent. Ms. Y will thus be paid an effective interest rate of 5.5 percent (6 percent minus 0.5 percent).
Viewing the computation
Interest: 100,000 x 5.5 percent (6 months) = 5,500
Pre-Maturity Value: Rs. 1,05,500 for six months.
Therefore, while calculating returns on a fixed deposit, more factors than only the interest rate should be taken into account. Planning and calculating the impact on your total return is particularly crucial in case you need to break the fixed deposit due to an early withdrawal.
Some banks provide early withdrawals without imposing any penalties. However, even in those situations, you should examine the actual interest rate that you would pay on a premature withdrawal, just like in our example, where, due to premature withdrawal, the interest rate was revised from 8 percent to 6 percent.
Tax Deductible on Source and Interest Thereon
The bank is obligated to deduct TDS at a rate of 10% from the interest generated on fixed deposits. There are two exceptions to the rule, though:
On interest generated on a savings account, no TDS must be taken.
If the interest earned on a fixed deposit is less than Rs. 10,000, no TDS must be withheld. This Rs. The 10,000 limit is per bank. As a result, if a bank pays interest on a Fixed Deposit that is greater than Rs. 10,000, i.e., Cumulative on all FDs, they must deduct TDS at a rate of 10%.
However, no TDS must be withheld if each bank pays an annual interest total of less than Rs. 10,000, such as when one bank pays an annual interest total of Rs. 8,000 and the other pays an annual interest total of Rs. 7,000.
By applying Form 15G or Form 15H to the bank, as described here: Form 15G and Form 15H to Reduce TDS on Interest, TDS on Interest may also be decreased.
Conclusion
Both savings accounts and FD (Fixed Deposit) are two significant methods of banking utilized by Indian citizens for storing their hard-earned money. An average Indian Household will hold at least one savings account and an FD account, which may be kept for reasons ranging from the marriage or education of their children to retirement plans they are making.
Hence, it is essential that we understand how this works and how interest is earned on deposits made by you, as well as the impact of a withdrawal. With this article, we aim to explain the concept using an example for a more precise and simpler understanding.
