With a fixed deposit you place a lump sum with a bank for a chosen period, anywhere from 7 days to 10 years, at a rate fixed on the day you invest. The bank pays that rate for the full term no matter what happens to interest rates afterwards, which is what makes an FD predictable in a way almost nothing else is.
How the return is actually calculated
Most bank FDs compound quarterly, which is why the maturity value is a little higher than simple interest would suggest.
Put Rs 1,00,000 into a 5-year FD at 7% compounded quarterly and it matures at roughly Rs 1,41,478. Simple interest at the same rate would have given Rs 1,35,000. The extra Rs 6,478 is interest earning interest: modest over five years, and the reason longer terms pull ahead disproportionately. You can test any combination in the FD calculator.
Note that the advertised rate is annual. A "7% FD" does not pay 7% per quarter.
Cumulative or payout
An FD comes in two shapes, and the right one depends on whether you need income now.
A cumulative FD reinvests the interest, so nothing is paid out until maturity and the whole sum compounds. This is the version that produces the Rs 1,41,478 above, and it suits anyone who does not need the money in the meantime.
A non-cumulative FD pays interest out monthly or quarterly. The total return is slightly lower because nothing compounds, but it produces regular income, which is why retirees frequently choose it.
How safe it really is
Deposits are insured by the DICGC up to Rs 5 lakh per depositor per bank, and that limit is worth reading carefully. It covers principal and interest combined, it applies per bank rather than per deposit, and it aggregates across all your accounts at that bank including savings.
Someone holding Rs 12 lakh at a single bank is insured for Rs 5 lakh, not Rs 12 lakh. Spreading large sums across banks is the straightforward fix, and it matters most with small finance banks and co-operative banks, which is precisely where the highest advertised rates tend to appear. A higher rate is compensation for higher risk, not a free gift.
Tax, and the TDS threshold people miss
FD interest is fully taxable at your slab rate, and it is taxable as it accrues each year, not only when the deposit matures. People with 5-year cumulative FDs are regularly caught out by this, having declared nothing for four years.
Banks deduct TDS once interest crosses the annual threshold, and that deduction shows in your Form 26AS and AIS. If your total income is below the taxable limit you can file Form 15G, or Form 15H if you are a senior citizen, to stop the deduction, but neither form makes the income tax-free, only the withholding.
Senior citizens also receive a higher interest rate at most banks, usually around half a percentage point.
Breaking it early
You can withdraw before maturity, and it costs you twice. The bank applies a penalty, typically around 0.5% to 1%, and, more significantly, recalculates your interest at the rate applicable to the period you actually stayed invested, not the rate you originally booked.
Break a 5-year FD after 18 months and you earn the 18-month rate minus the penalty, which can be far below what you expected. Splitting a large amount into several smaller FDs is a simple hedge: you break only the one you need.
Where an FD fits
An FD is the right home for money you cannot afford to see fall: an emergency fund, a house deposit you need next year, cash you will spend within a defined period. It is a poor vehicle for long-horizon wealth building, because the post-tax return often barely clears inflation.
For goals a decade away, a SIP into equity has historically done far better while being far more volatile along the way. The comparison in our PPF vs FD vs NPS guide sets out where each one belongs. See also recurring deposit if you want FD-like safety but are saving monthly rather than investing a lump sum.