Premature closure of post office (DF) term deposit has severe impact on interest income | Photo credit: ANI
A Postal Term Deposit or Postal Term Deposit (POTD) is similar to a fixed bank deposit in which the deposited money accumulates predefined interest throughout the investment period. They are safe investments guaranteed by the government in which the depositor gets money invested and interest earned at maturity.
The RBI announced a new rule that the unclaimed amount in this matured fixed deposit system offered by the Indian Postal Service generates an interest rate applicable to the savings account or the contacted rate of the FD arrived at. maturity, whichever is lower. However, returns are not hedged against inflation, as actual returns turn negative when the interest rates offered on the POTD are lower than the rate of inflation. Returns are positive when the rate of return is greater than inflation.
Currently, the return on POTD investments depends on the mandate chosen. The current interest rate on the POTD is 5.5% for a term of 1 year which means the amount will double in 13 years and for an investment term of 6.7% the rate of return is 6.7%. Interest is payable annually but calculated quarterly. These are available for terms of 1, 3 and 5 years. The interest rates on these are communicated quarterly and are aligned with the G-sec rates of similar maturity, with a spread of 0.25%. However, once invested, the interest rates remained unchanged for the duration of the investment.
POTD schemes are liquid despite the investment lock-up period, as the depositor may borrow on the deposit or withdraw the amount prematurely. However, it should be noted that premature closure or withdrawal is only allowed after 6 months from the deposit. In the event of early withdrawals after 6 months but before 1 year, the interest rate is reduced to 4%. Withdrawal after 1 year, earn 1% less interest rate for the chosen term.
|Duration of the deposit||FD post office rate (pa)|
Calculation of the interest rate in the event of early withdrawal
It should be noted that a premature withdrawal before the tenure competition severely impacts the interest income on the investments. For example, an investment of Rs 5 lakh for a period of 5 years at an interest rate of 6.7% will yield interest income of Rs 34,351 each year which is added to the principal. But if closed due to financial hardship or need, let’s say after 3 years the maturity amount will be reduced to just Rs 4.50,140 which is 48% interest loss under current rules . In this case, the loss is much more than a premature withdrawal in case of bank deposits.
In the above case, the depositor was receiving interest of Rs 34,351 annually at 6.7% per annum. However, because the scheme was prematurely closed, the interest rate supposed to be charged on the investment will be Rs 17,351 at an interest rate of 3.5%. The excess interest rate of Rs 49,860 is [Rs 1,03,053 (Rs 34,351 received for three years) – Rs 53,193 (Rs 17,351 for three years)] will be recovered on the principal amount of Rs 5 lakh.
Premature withdrawal: Higher interest loss in POTD than Bank FD
- No deposit will be withdrawn before the expiration of six months from the date of the deposit.
- If the Term Deposit Account (TD) is closed after 6 months but before 1 year, the PO savings account interest rate will apply
- If the TD 2/3/5 Year Account is prematurely closed after 1 year, interest will be calculated at 2% less than the TD Interest Rate (i.e. 1/2/3 years) for completed years, and for a partial period of less than one year, PO Savings Interest rates will apply.
- The TD account can be closed prematurely by submitting the prescribed application form with passbook to the relevant post office
Post office FDs offer higher interest rates than bank FDs, but have a liquidity cost. The loss of interest is likely to be much greater for premature withdrawal in post office term deposits than bank FDs which charge a 0.50-1% penalty. So how will the early closing impact your investments in POTD versus bank FDs. In the first case, you simply cannot withdraw any money before the end of the 6 months, while bank FDs can be liquidated even the next day in the event of an investment. The amount at maturity in the event of POTD will depend on the mandate chosen and the period within which you will liquidate it before the end of the mandate.
For example, if you prematurely close a 5-year term deposit in 4 years, the interest payable on the investment will be equal to the interest rate in effect for the 3-year term deposit when the 5-year POTD was. open. The same goes for the conditions set for the premature closure of bank FDs. It should be noted that even if you continue the 5 year POTD for say 4 years and 3 months, only the normal 4% Postal Savings Account interest will be paid for the past months. As of April 2021, a 5-year POTD earns 6.7% interest while a 3-year term deposit gets 5.5% interest, which translates to a loss of 1.2 %.
As an illustration, suppose deposit A invested Rs 1 lakh in a 5-year postal term deposit on April 1, 2021 and had to withdraw prematurely on May 31, 2025, the investment would only have been made in 4 years and 2 months only. In this case, an interest rate of 5.5% applicable on a 3-year term deposit on April 1, 2021, will be granted which amounts to Rs 1,24,421.05. For the remaining two months, the Swiss Post savings rate of 4% will apply. The additional interest for these two months amounts to Rs 829.47. Thus, the total amount payable will be Rs 1,25,250,53. This amount at maturity would be Rs 1,39,406.69 if the investment had been made for the entire 5-year period.
The situation is even worse if the POTD is closed say after 1 year but before 4 years. In this case, the interest paid would be 2% lower than the interest given for a POTD of 1 year, 2 years or 3 years of seniority