What are term deposits and how do they work?

Oct 10, 2019
Whether or not term deposits will work for you depends on your savings goals. Source: Getty.

For retirees who are looking to make their savings stretch further in retirement or create some extra income outside of superannuation, term deposits have long been a safe and popular option. But, before you rush to invest, do you know what term deposits are and how they work?

Term deposits are savings products offered by banks, credit unions and building societies across Australia, offering customers a fixed rate of interest over a set period of time (aka the ‘term’). Due to the fixed rate of interest, these products can offer good returns, however you must be willing to leave your cash untouched for the duration of the term, or risk additional fees.

In recent years interest rates have plummeted and just last month the Reserve Bank of Australia slashed the cash rate to an historic low of just 0.75 per cent, which have flowed on to customers in the form of lower interest rates at many of the country’s major financial institutions.

However term deposits still remain largely popular due to the peace of mind they offer customers, particularly those over-65 who have limited means of generating income having given up work and taken the plunge into retirement.

Do you have long or short term savings goals?

When deciding whether term deposits are a good investment choice for you, it is important to consider what outcome you are hoping to achieve. Are you looking for quick returns to help you reach a short-term goal, or are you prepared to leave your savings untouched for a considerable amount of time?

If you simply want to save up enough for an upcoming holiday or to help your children or grandchildren put aside enough for a house deposit or wedding, then a term deposit account may not be the most appropriate choice. You may be better served by an at-call savings account, which operate more like traditional savings accounts in that you can access your funds whenever you like and as often as you like, as there is no fixed term period.

However at-call investment accounts do tend to offer lower rates than term deposits, meaning you stand to make less money over time.

If you are willing to play the long game though then term deposits could work for you and, if you can resist the temptation of withdrawing your money early, you could benefit from higher interest rates. It’s vital you know what your goals are though as term deposit accounts often enforce a 31-day notice period if you want to break the agreement and withdraw your funds before the fixed period is up. You could also be paid a reduced rate of interest and incur a penalty fee as a result.

Compare the interest rates on offer

Last month the Reserve Bank of Australia made history when it announced it was slashing the cash rate to an all-time low of 0.75 per cent. In line with the cut, banks and financial institutions across the country in turn reduced the interest rates they offer their customers, hitting savers and retirees the hardest.

However there are still competitive interest rates to be found so it really pays to do your research before investing your hard-earned savings in a term deposit account. You can do this by using one of the many comparison websites available online – including Canstar, Finder and Compare the Market – to check with provider offers the best rate.

Many financial institutions also offer competitive rates in a bid to entice new customers, while it is also worth noting that the rate you receive may also depend on the size of your deposit as well as the length of the term.

The pros and cons of term deposits

The biggest benefit of term deposits is that you are guaranteed to be paid the same rate of interest for the full term of your agreement, no matter whether the cash rate drops. This is not the case for traditional savings accounts where the interest rate you receive can fluctuate giving you no guarantee as to what return you stand to make on your investment.

According to the RBA, the average return rate on term deposits in Australia is currently 1.30 per cent per annum, which is a significant drop when compared with the same period last year when rates were sitting at 2.20 per cent per annum.

These low rates are all the more significant for retirees as the current deeming rate for large investments sits at a much higher 3 per cent, while the rate for smaller investments is currently 1 per cent.

The government uses the deeming rate to estimate the amount of income that retirees generate through their financial assets. Treasurer Josh Frydenberg announced he was adjusting the rates in July this year, following an outpouring of discontent from older Australians following the first of many cash rate cuts by the RBA.

You can find ‘retail deposits and investment rates’ at rba.gov.au/statistics/tables

Important information: The information provided on this website is of a general nature and for information purposes only. It does not take into account your objectives, financial situation or needs. It is not financial product advice and must not be relied upon as such. Before making any financial decision you should determine whether the information is appropriate in terms of your particular circumstances and seek advice from an independent licensed financial services professional.

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