Investing in corporate FDs? Know these risks involved
New Delhi: Over the last couple of months, the interest rate offered by leading banks on fixed deposits have fallen which has made FDs an unattractive investment instrument especially for individuals in the highest tax slab and senior citizens. In such a situation, financial planners have been suggesting that people should try investing in corporate fixed deposits that offer slightly higher interest than bank FDs depending on the quality of the issuer.
What are Corporate FDs?
Corporate fixed deposits are offered by companies. When companies need to raise cash in a hurry they offer fixed deposits at attractive interest rates. Investors are issued deposit certificates of different tenures at fixed interest rates.
Companies that have high ratings offer interest rates on different tenures of corporate fixed deposits of 1-5 Year tenure. The interest rates vary from 8.00 per cent – 10.75 per cent depending on the tenure. Companies with a lower rating offer higher interest rates than the highly-rated ones to make up for the default risk.
However, due to the financial stress created by the pandemic, corporate balance sheets have become stressed which is why analysts advise that one has to be selective while investing in corporate FDs. Analysts recommend investing only in AAA-rated corporate FDs for better safety of your capital. At present, AAA-rated corporate FDs offer between 6-8% interest depending on the tenor of investment.
If you are planning to invest in corporate FDs, know these risks:
1. Default risk: While investing in corporate FDs, one must remember that unlike bank FDs, these are not secured. This means that these FDs neither guarantee any capital protection nor interest payments meaning an investor may lose his money if a company faces financial distress.
2. Unattractive post-tax returns: In the case of corporate FDs, investors are taxed according to the income tax slab they fall under. Therefore, those in the highest tax bracket will pay more tax. According to the Income-tax Act, 1961, the tax will be deducted at source (TDS) on the interest earned from a company deposit, if the interest exceeds the limit of Rs 5,000 per year. However, you can save on TDS by submitting Form 15G (or Form 15H for senior citizens), if eligible to do so, to the bank or NBFC.
3. Penalty on premature withdrawal: It is also worth remembering that some corporate fixed deposits do not allow premature withdrawal for a period of three-six months and in case a premature withdrawal is made, no interest accrues on the deposit. On premature withdrawal after six-twelve months, certain companies deduct around 2-3 per cent on the interest rate offered.
Most company FDs come with a lock-in period of three months when an investor cannot take out any sum. Even after the lock-in period is over, withdrawal before maturity means closing the complete FD. An investor will have to let go some interest in case of making a withdrawal before the FD matures.