What is a term deposit?
The investment world can be a smorgasbord of flavours, but sometimes plain vanilla - or a term deposit - is all you want or need.
This is an arrangement between you and a bank or other financial institution, in which you agree to invest a set amount of money with them for a certain period of time at a fixed rate of interest. During that time the money is effectively locked away - you cannot touch it without incurring penalties - but this gets you the better interest rate than if your funds were easily accessible.
When your term deposit matures at the end of your agreed investment period, you'll be given two choices: you can either have the interest and principal (the original funds you invested) deposited into your savings account, or you can re-invest it along with the principal into a new term deposit - this is called 'rolling over'.
The interest rates on term deposits usually get better the longer your money is invested. Although many institutions will offer more enticing 'honeymoon' rates, it is generally only for a period of three months and a one-time only offer.
You also have options when it comes to how frequently you want the interest to be paid. In most cases it will either be every 6 months or annually. Don't be alarmed if you opt for every 6 months and the interest rate is a touch less than the annual rate - this is normal! It is lower because it assumes you will reinvest the interest at the lower interest rate. This would give you the same interest rate as an annual payment.
As with many investment options, there are arguments for and against term deposits.
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Pros |
Cons |
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It’s low risk. |
You might be able to get better returns in shares or property (but there’s a greater amount of risk). |
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Term deposits can mature within months or years. You can shop around for the best interest rate. |
If you want to access your money before the agreed maturity date, you may have to pay a fee. |
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The Australian Government guarantees deposits up to $250,000 per person. |
If your term deposit matures and you choose to roll it over into a new one, you may not get the same ‘honeymoon’ interest rate that you got for your first term deposit. |
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Term deposits often offer a better interest rate than a standard bank account (the kind of bank account you use for daily transactions). |
How do you use your term deposit?
At brightday we reckon self-directed retirees should have at least three to four years worth of pension payments available in cash, within their super fund. This means even if you have the rest of your portfolio invested in growth investments, you won’t need to sell these in a pinch to fund your pension.
This really applies to those in Complete Pension or an SMSF who invest in managed funds, separately managed accounts or directshares. If you are in an industry fund, depending on the option you have selected there would likely be a portion of your investment option already in cash so it isn’t something you need to worry about.
Having a couple of years of pension payments on hand will mean you end up with a pool of cash that you don’t need to use anytime soon, so term deposits are a perfect investment option. With four years worth, you may divide it into two investment categories to maximise your returns - for two years of payments, a longer dated term deposit between two and four years. For the remainder, a shorter dated term deposit between six months and two years.
As an example, Sarah & Peter Wilson are both 60 and retired with $625,000 in their SMSF. They need to take out $24,000 this financial year to meet their minimum pension requirements. Noting the suggestion of four years worth of pension, it means they might need around $100,000 of cash, which they have already got.
This is how they decide to spread out their term deposits.
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$25,000 |
At call - for pension payments |
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$25,000 |
Invested for one year |
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$25,000 |
Invested for two years |
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$25,000 |
Invested for three years |
In Complete Pension, the longest maturity term deposit you can have is one year.
‘Breaking’ your term deposit
While you generally cannot access the funds in your term deposit until it matures, sometimes the unexpected happens and you just might have to. This involves ‘breaking’ the term deposit and comes at a cost. There might be set charges to break the term, much like there is when breaking a lease or getting out of a gym contract early. On top of that, your bank or financial institution will also likely reduce the interest rate, using a formula to calculate the length of the term that was fulfilled and adjust the interest rate accordingly.
Depending on the size of the deposit and the length of the investment term, the interest you sacrifice by breaking the deposit early could sting. Always find out how much it will cost you to break - if it seems too costly or you don’t have long to go until it matures you might be better off considering other options.
The government guarantee
If you deposit up to $250,000 in a bank, building society or credit union, the Australian government will guarantee you get it back if that institution runs into financial difficulty. This arrangement came into place following the GFC in 2008. The government’s Moneysmart website has more information on the caps, conditions and eligible institutions of the government guarantee for deposits up to $250,000. This only applies to term deposits arranged under Total SMSF or Flexi SMSF. Complete Super and Complete Pension term deposits are held under a custodian arrangement and are not eligible for the government guarantee.
brightday only deals with authorised deposit-taking institutions (ADIs) that are covered under the government guarantee.