Fixed Deposit: How It Works, Rates, Penalty and Tax Explained

Last updated 18 October 2026 · 12 min read

A fixed deposit is one of the first investments most Indian families ever make, and one of the least understood. People book one because a parent did, or because the bank offered it at the counter, and then never quite learn how it works. How is the interest worked out? Why does a bank pay you less if you break the deposit early? Is the interest taxed even if you never touch it?

This guide answers all of that in plain words, with a rupee example for every idea. If you are only starting to put money aside, read our guide on how to save money first. And for the everyday account that sits beside an FD, see our guide on the savings account.

What Is a Fixed Deposit?

A fixed deposit (FD) is a deposit where you give a bank a lump sum for a fixed period, and the bank pays you a fixed rate of interest on it. Because you agree to leave the money untouched, the bank pays you more than it would on a savings account. The rate on the day you book is generally the rate you keep until the end.

Why does the bank pay more? A bank lends deposits out to borrowers. If you may withdraw tomorrow, the bank cannot lend your money for long. If you promise three years, it can plan around that, and it rewards the certainty with a higher rate.

A few words come up again and again: - Principal is the amount you deposit, such as ₹1,00,000. - Tenure is how long the money stays locked in, from a few days up to 10 years. - Maturity is the end of the tenure, when the bank returns your principal with the interest. - Maturity amount is the principal plus all the interest you earned.

How Fixed Deposit Interest Works

Interest on an FD can be worked out in two ways. Simple interest is paid only on your original principal. On ₹1,00,000 at 7% for 3 years it is ₹1,00,000 × 7% × 3 = ₹21,000, so the maturity amount is ₹1,21,000.

Compound interest is paid on the principal and also on the interest already earned. This is how most FDs work. We explain the idea in our post on simple vs compound interest.

Here P is the principal, r is the yearly rate as a decimal (7% is 0.07), n is how many times a year interest is added, and t is the years. Most banks add interest every quarter, so n is 4. For ₹1,00,000 at 7% for 3 years, the quarterly rate is 1.75% over 12 quarters, and the result is ₹1,23,144, so the interest is ₹23,144.

Compare the three ways on the same deposit: - Simple interest gives ₹1,21,000. - Compounding once a year gives ₹1,22,504. - Compounding every quarter gives ₹1,23,144.

The quarterly FD earns ₹2,144 more than simple interest, and you did nothing extra. The longer the tenure, the bigger the gap grows.

Interest rate and effective yield

A 7% rate added every quarter grows your money by about 7.19% in a year. That 7.19% is the effective yield, the true yearly growth. When two banks quote the same rate but add interest at different intervals, the one that adds it more often pays slightly more. So compare the maturity amount, not only the headline rate.

Try It With Your Own Numbers

You can also test other amounts in the compound interest calculator.

Types of Fixed Deposits

• Cumulative FD. Interest is added back and paid together at maturity, as in the example above. It suits you if you do not need regular income.
• Non-cumulative FD. Interest is paid out monthly or quarterly. On ₹1,00,000 at 7% with a monthly payout you get about ₹583 a month. Because the interest leaves the deposit, it does not compound. Retired people often prefer it.
• Tax-saver FD. A 5-year lock-in you cannot break. Under the old tax regime you can deduct up to ₹1,50,000 a year of what you put in. That is a deduction, not a tax-free deposit: the interest is still taxable, and the deduction is not available under the new regime.
• Senior citizen FD. Banks pay people aged 60 and above a higher rate, explained below.
• Sweep-in FD. Linked to your savings account, so idle cash earns the FD rate and still reaches you when needed. We explain how it helps a safety cushion in our guide on emergency fund.

Best Fixed Deposit Interest Rates

Everyone searching for the best fixed deposit interest rates wants one number. The honest answer is that there is no permanent winner. Banks reset rates from time to time, and the highest rate is not always the best deal. So instead of a rate chart that will be out of date next month, here is how rates are shaped and how to judge them.

Rates differ by the type of bank

As a rough picture in 2026, larger banks pay about 6 to 7% a year on common tenures. Small finance banks often pay more, commonly about 7 to 8%, because they must attract depositors who would otherwise choose bigger names. The post office time deposit has its own rates: for October to December 2026 it pays 6.9% for 1 year, 7% for 2 years, 7.1% for 3 years and 7.5% for 5 years. Treat these as a guide and check the current rate before you book.

Rates differ by tenure and age

A longer tenure often earns a higher rate, but not always. Some banks pay their best rate on 1 to 3 years. Senior citizens (60 and above) usually get an extra 0.25 to 0.75 percentage points, most commonly 0.50. On ₹5,00,000 for 3 years with quarterly compounding, that gap is worth roughly ₹9,000 at maturity.

How to compare two FDs

1. Compare the same tenure. A 2-year and a 5-year rate lock your money for different lengths.
2. Compare how often interest is added. More often means a slightly higher effective yield.
3. Compare the maturity amount, not the rate. On ₹5,00,000 for 3 years, 6.5% grows to ₹6,06,704 and 7.5% to ₹6,24,858. That one point is worth ₹18,154.
4. Check the safety of the bank. A rate far above the others is a signal to ask why.
5. Check the exit rules. The best rate on paper is no good if you may need the money early.

How to Book a Fixed Deposit

Booking takes a few minutes, online or at a branch. Choose the amount, the tenure and cumulative or payout. Decide what happens at maturity: credit to your savings account, or renewal. Add a nominee, give your PAN (it affects how tax is deducted), and keep the deposit receipt. Note the maturity date in your calendar.

Premature Withdrawal: What Happens If You Break an FD

Most FDs can be broken early, at a cost. The usual rule has three parts, though details differ by bank: - The bank pays the rate that applied to the period you actually held the deposit, not the rate you booked. - It then deducts a penalty, typically 0.5 to 1 percentage point. This is a cut in your rate, not a fee on your principal. - If you break it within a very short time, such as the first week, you may get little or no interest.

Example: you book ₹1,00,000 for 5 years at 7.5%. After 3 years you need the money. The bank's 3-year rate was 7% and the penalty is 1 point, so you are paid 6% for the 3 years. With quarterly compounding that is ₹1,19,562. A 3-year FD at 7% from the start would have given ₹1,23,144, so breaking early cost you ₹3,582. You also gave up the ₹1,44,995 a full 5-year term would have paid.

Ways to avoid breaking a big FD

• Use a ladder. Split the money into several FDs. With ₹2,00,000, one FD forces you to break everything for a small need; four FDs of ₹50,000 let you break only one. Put ₹5,00,000 into five FDs of ₹1,00,000 maturing in 1, 2, 3, 4 and 5 years, and one comes due every year.
• Take a loan against the FD. Many banks lend about 60 to 90% of the deposit at a rate a little above the FD rate. The FD keeps earning, but you pay interest on the loan. If you want to see what a loan costs, use the loan EMI calculator.
• Keep emergency money elsewhere. Money you may need quickly belongs in a savings account, as our guide on emergency fund explains.

Tax on Fixed Deposit Interest

FD interest is taxable. It is added to your income and taxed at your slab rate, under "income from other sources". Three rules matter: - Cumulative FDs are taxed every year. Even if interest is paid only at maturity, it is generally taxed each year as it builds. On ₹1,00,000 at 7% compounded quarterly, the first year's interest is about ₹7,186, and it counts as that year's income. - Banks deduct TDS. If interest from one bank is above ₹50,000 in a financial year (₹1,00,000 for resident seniors), the bank deducts 10% before paying you, or 20% if you have not given your PAN. On ₹60,000 of interest, TDS is ₹6,000. The limit applies to each bank separately, but you must report all your interest. - TDS is only an advance. In the 30% slab, tax on that ₹60,000 is ₹18,000, so you pay another ₹12,000 when you file. If your total income is below the taxable limit, you can ask the bank not to deduct TDS by submitting Form 121, which from 1 April 2026 replaces Forms 15G and 15H.

A 7% FD for someone in the 30% slab earns about 4.9% after tax, before cess. Add inflation of 6%, and the buying power of that money still falls. We explain this in our guide on how inflation affects savings. An FD is for safety and a known return, not for beating inflation.

Is Your Fixed Deposit Safe?

Bank deposits are insured up to ₹5 lakh per depositor, per bank, including principal and interest, across all your accounts in that bank together. If you hold ₹4,00,000 in an FD and ₹1,50,000 in a savings account at one bank, only ₹5,00,000 of the ₹5,50,000 is covered if that bank fails. Spread larger amounts across banks. Small finance banks carry the same insurance, though their finances can be weaker than a large bank's, which is one reason their rates are higher. The limit can be revised, so check the current figure.

When Does a Fixed Deposit Make Sense?

An FD fits when you will not need the money for a set period and want a return that does not move. - A goal with a fixed date. School fees of ₹3,00,000 due in 2 years: about ₹2,61,000 in an FD at 7%, compounded quarterly, grows to roughly ₹3,00,000. - Steady income. A retired person can use a non-cumulative FD for monthly interest. - The calm part of your savings. Keep daily money in a savings account and put money you will not need soon into FDs. - Small monthly saving. If you have no lump sum, a recurring deposit lets you build one at a fixed rate.

An FD is not the best fit for money you may need at short notice, or a goal 15 or 20 years away, where inflation eats into a fixed return. The SIP calculator shows what regular investing could do, though returns there are not fixed. For a lump sum, see SIP vs lump sum.

Common Fixed Deposit Mistakes

• Chasing the highest rate without checking the bank.
• Putting everything in one FD. It forces you to break all of it for a small need.
• Locking in your emergency money. Keep a same-day cushion, as in our emergency fund guide.
• Forgetting auto renewal. Many banks renew a matured FD at the current rate, which may be lower. Tell your bank what you want before maturity.
• Ignoring tax. FD interest is taxable even when never paid out.
• Putting more than the insured limit in one bank.

Frequently Asked Questions

Try It Yourself

Pick an amount you will not need for 3 years, say ₹1,00,000, and run it through the calculator above with the rate your bank offers. Write down the maturity amount. Then look up the penalty rules in your bank's app, work out the tax at your slab, and decide whether to split the money into two or three FDs of different tenures.

This article is for general information and education. It is not financial, tax or legal advice. Rates, limits and rules change, and all rupee figures are illustrative examples, so check with your bank, the official source or a qualified adviser before making decisions.