Fixed Deposits (FDs) are one of the most popular and safest investment instruments in India. They offer assured returns and flexible tenures. However, there may be instances where you need to break your FD before maturity due to financial emergencies or better investment opportunities. While premature withdrawal is allowed, many investors overlook the tax implications involved.
In this article, we’ll explore everything you need to know about the tax treatment, penalties, and reporting rules related to breaking an FD before its maturity date.
📌 What is Premature Withdrawal of FD?
Premature withdrawal means closing your fixed deposit account before the agreed maturity period ends. While banks and financial institutions allow this, it usually comes with:
- Lower interest rates than originally promised.
- Premature withdrawal penalties.
- Tax implications on interest earned.
🧾 How is FD Interest Taxed in India?
Before diving into the impact of early closure, it’s important to understand how FD interest is taxed.
| Category | Details |
|---|---|
| Taxable Income | FD interest is added to your total income under “Income from Other Sources”. |
| Tax Slab Applicability | Taxed as per your applicable income tax slab. |
| TDS Deduction | Banks deduct TDS (Tax Deducted at Source) if interest exceeds ₹40,000 (₹50,000 for senior citizens) in a financial year. |
| TDS Rate | 10% (if PAN is provided), 20% (if PAN is not provided). |
💥 Tax Implications of Breaking FD Before Maturity
Now let’s focus specifically on the tax effects when an FD is broken early:
1. Interest Earned Is Still Taxable
Regardless of whether you break the FD or let it mature, the interest earned is fully taxable in the year it is credited to your account (on accrual or receipt basis, depending on your accounting method).
🧠 Even if you receive a lower interest rate upon premature withdrawal, the interest amount you actually earn will be taxed as income.
2. Revised Interest Calculation
When you break an FD, the bank recalculates your interest based on the actual period the FD was held, often at a lower rate.
Example:
You booked a 1-year FD at 7% interest, but broke it after 6 months. The bank might pay you 5.5% (the prevailing rate for 6-month FDs), and deduct the penalty (e.g., 0.5%).
| Particulars | Amount |
|---|---|
| Original FD Rate | 7% |
| Revised Rate for 6 mo. | 5.5% |
| Less: Penalty (0.5%) | Final Rate = 5% |
| Interest Earned | Taxable in same FY |
📅 In Which Year is the Interest Taxed?
- Accrual Basis: Interest is taxed every year as it accrues, even if not withdrawn.
- Receipt Basis: Taxed in the year you receive it (applicable if you follow cash basis accounting).
If you break the FD before year-end, interest will be included in your total income of that financial year.
📄 Is TDS Still Deducted If FD is Broken Early?
Yes. If your total FD interest exceeds ₹40,000 (₹50,000 for seniors) in a year, TDS will be deducted by the bank, even on prematurely withdrawn FDs.
| Scenario | TDS Applicability |
|---|---|
| FD broken within the same FY | TDS is applicable if interest crosses limit |
| FD spans multiple years but broken early | TDS is based on actual interest paid till date |
✅ Tip: Submit Form 15G/15H if your income is below taxable limit to avoid TDS.
🧾 Reporting FD Interest in ITR
When filing your Income Tax Return (ITR):
- Disclose interest income under “Income from Other Sources”.
- Include it even if TDS is already deducted.
- Claim TDS credit under Schedule TDS in ITR.
🚫 Common Myths About FD Taxation
| Myth | Reality |
|---|---|
| FD interest is tax-free if FD is broken early | ❌ FD interest is always taxable |
| TDS is the final tax, no need to report in ITR | ❌ TDS is only a partial tax; total liability may vary |
| No TDS = No tax liability | ❌ You must pay tax if interest crosses basic exemption |
✅ How to Minimize Tax on FD Interest
- Split FDs across banks to keep interest below TDS threshold.
- Invest in tax-saving FDs (lock-in 5 years, eligible under 80C).
- Choose cumulative FDs to defer interest and reduce TDS in early years.
- Use Form 15G/15H if eligible to prevent TDS deduction.
- Plan maturity and breakage to fall under lower income years.
🧮 Quick Tax Illustration
| Particulars | Value |
|---|---|
| FD Principal | ₹2,00,000 |
| Original Rate | 7% |
| Tenure | 1 Year |
| Broken After | 6 Months |
| Revised Rate | 5.5% – 0.5% = 5% |
| Interest Earned | ₹5,000 |
| TDS Deducted (if PAN given) | ₹500 (10%) |
| Taxable Income Addition | ₹5,000 |
🧾 Conclusion
Breaking an FD before maturity is sometimes necessary, but it’s crucial to understand the tax impact along with the financial consequences. The interest you earn is always taxable, and may attract TDS if thresholds are breached. By planning wisely—such as choosing the right tenure, spreading deposits, and using TDS exemption forms—you can minimize tax outgo and optimize your returns.
FAQs
Q1. Is the penalty for premature withdrawal taxable?
No, the penalty is simply a deduction from your interest rate, not an additional tax.
Q2. If I don’t earn ₹2.5 lakh annually, do I still need to pay tax on FD interest?
If your total income including FD interest is below the exemption limit, you won’t need to pay tax—but still must report it in your ITR.
Q3. Will I get TDS refund if my tax liability is lower?
Yes. File your ITR and claim a refund of the excess TDS deducted by the bank.