Term deposits can be confusing. Given the different interest rates and time periods the banks offer, there are a few things to think about to get the best deal overall and put the most money in your pocket.
How to earn more interest on your term deposit
Get a good interest rate
There are a number of comparison sites like www.choice.com.au and www.cannex.com.au that have been set up to help consumers find the best deal. There are a number of other comparison sites which, although wanting to help consumers, make their money when the banks pay them after receiving a sign-up through their site.
Consider the effect of compounding interest on the rate offered
The more often interest is paid, the more interest you will earn. This is called compounding, which Einstein called the 8th wonder of the world.
Example: $10,000 compounded monthly or yearly
$10,000 invested at 5.5% interest will earn $550 in a year, resulting in a balance of $10,550. However if the money was compounded monthly it would earn $564 interest in a year. An extra $14 isn’t much in one year, but over time this can add up.
Also, consider that extra $14 is 0.14%, so the actual interest rate for compounding monthly is 5.64%, rather than the 5.5% for compounding yearly.
The longer the period, the less attractive the interest rate is. For example, a quarterly (three month) term deposit could be rolled over (and compounded) four times before the one year term deposit expires.
Banks want you to deposit for longer, so they will reduce their interest rates for shorter periods
Unfortunately, banks usually want you to keep your money with them for longer, so will adjust their interest rates accordingly.
I noticed one bank adjusted their less-than-a-year rates to compound to exactly 3.85% in a year. This meant that given the quarterly rate was 3.80%, if you rolled over that rate four times you would have the same amount as if you had earned the yearly rate of 3.85%.
Other banks just reduce their quarterly or six monthly interest rates because they want to enjoy your holiday (I always love the Rabobank ads!).
How to reduce or defer the tax on your term deposit
Do you want your term deposit to mature in the next tax year?
You are taxed on a cash basis when you receive interest income. So if your term deposit matures after 1 July, the whole amount of interest will go into next year’s tax. This could be a benefit to deferring your tax, or it could be a negative if you will be in a higher tax bracket next year.
If you will be in the same tax bracket this year and next, getting the best deal is probably more important to you than paying tax later.
Whose name should the term deposit be in?
If you have a partner, you might consider whether the term deposit should be setup in joint names or your partner’s name only. This is one of the easiest ways to ‘structure’ your affairs to save a bit of tax, if you or your partner will be on a lower marginal tax rate for the tax year. Putting the term deposit in your children’s name is a silly option, because given the ATO penalty rates you might end up paying 66% tax.
Other factors to consider when deciding on a term deposit
Do you want your term deposit to mature more often?
Having your term deposit mature more often means you can access the money (without attracting penalties from the bank). But the banks are less likely to give you a high interest rate.
Why do the banks change the interest rates?
Aside from setting different interest rates to make the most money, banks also try to estimate what the future interest rates are going to be. They may also set the deposit rates according to how much they want your money.
Good luck picking the right term deposit!