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Term deposits

Term deposits are an easy way for you to “set and forget” a sum of cash at your bank while also earning a higher rate of interest than you’d get from a savings account. But what are the potential pitfalls?

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You should know what to do if you want to break a term deposit, how much notice you may have to give your bank and what happens to your funds when the deposit matures.

Early withdrawal

Most banks have a “cooling-off” period when you set up or reinvest a term deposit. During that time you can cancel your term deposit, or change the term or amount. If you cancel it, you won’t earn any interest.

Kiwibank, SBS Bank and TSB may let you break your term deposit in the first 30 days with no penalty – you just won’t receive any interest.

Outside the cooling-off period, you can apply to your bank to withdraw funds early. Until recently banks didn’t require customers to give notice to break a term deposit.

However, the Australian-owned banks, ANZ, ASB (including BankDirect), BNZ and Westpac have introduced tougher rules for early withdrawals of term deposits. Term deposit holders now have to give 31 days’ notice, or 32 days in Westpac’s case, unless they’re experiencing hardship.

The new rules are due to Australian regulatory requirements introduced in response to the global financial crisis. The Australian regulators want their banks to always have enough cash on hand to cover withdrawals and not default on loans, thereby setting off a run on the banks in Australia. A “liquidity coverage ratio” now determines how much money banks must have on hand. Term deposits are part of this on-hand money. The Australian banks have chosen to introduce the same notice period for customers of their New Zealand subsidiaries.

New Zealand has its own liquidity ratio requirements but these don’t specify a notice period for term deposits. Banks such as Kiwibank, The Co-operative Bank, Heartland Bank, RaboDirect, SBS Bank, and TSB don’t have a notice period … yet. Associate professor David Tripe, director of Massey University Centre for Financial Services and Markets, believes it’s only a matter of time before our Reserve Bank introduces similar regulations.

Interest reductions

If you break a term deposit early, there are penalties.

You’ll get less interest or may be charged a fee. For instance, your interest rate may drop by a certain percentage (see Term deposits compared). This could be a reduction from the original rate or from the rate that applies to the actual term of your investment. You may even end up with no interest.

What happens if you’ve already been paid interest before you break your term deposit? For instance, you may receive monthly interest paid into your regular bank account. In this situation the amount you withdraw gets reduced to reflect the difference between the payments already made and what’s now payable.

Be aware, an early withdrawal of a term deposit might mean you overpay withholding tax on any interest you’ve already received. You can apply for a refund by contacting IRD.

Partial withdrawal

If you don’t withdraw the full amount of your term deposit, you should still receive the original interest rate on anything you leave – as long as the amount you leave doesn’t drop you to a lower tier of interest. In that case, you’ll usually get the rate that applied to the lower tier at the date of your original investment.

Kiwibank and Westpac allow you to withdraw, without any reduction in interest, up to 20 percent of your term deposit for investments over certain terms.

For deposits with terms of two or more years at Kiwibank, you can withdraw up to 20 percent at any time, and as many times as you like, without an interest rate reduction. At Westpac you can access up to 20 percent on term deposits of one or more years. But you must give 32 days’ notice and you can only do it once. These withdrawals also can’t drop you into a lower tier.

Hardship rules

If you need to break your term deposit due to hardship no notice is required.

An inability to pay essential living costs due to illness, unemployment, or relationship separation, urgent medical expenses, funeral costs, or costs due to a disaster may qualify as hardship.

Hardship won’t cover paying non-essential costs such as mobile phone bills, holiday expenses, gym memberships, home renovations, gifts and donations. While Westpac includes paying traffic or other fines as examples of non-essential costs, ASB includes fines imposed by courts or legal process under its list of what may qualify for hardship.

The bank makes the decision whether you’re in hardship and you may be required to provide evidence. If you have funds in other accounts ASB may require you to use those first before allowing you to break a term deposit.

Reaching maturity

Your term deposit is nearing the end of its term. What happens next? When you set up your term deposit you may have given the bank instructions on what you wanted it to do. For instance, you might want the principal and interest paid into another bank account, or you might have instructed the bank to roll over the money for another term.

No matter what you said when you started your term deposit, most banks will contact you before your term deposit is due to mature. If you haven’t given any maturity instructions, banks will usually roll over your term deposit, both the principal and any unpaid interest, into another investment with a similar term at the current rate.

At RaboDirect, if you don’t choose to automatically reinvest, your matured term deposit is put into a RaboSaver account that is set up when you start your term deposit. Any interest you have been paid during the term is also paid into the RaboSaver account.

We say

  • Try to work out if and when you’re likely to need the funds before fixing the term. Check your bank’s terms and conditions with respect to breaking term deposits.
  • Consider alternatives if you think you may need the funds at short notice. A savings account or call account might be a better option, even if the interest rate isn’t as attractive.
  • Set a reminder for shortly before your term deposit is due to mature.

Term deposits compared

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Holding back

If the bank receives a demand under certain laws or a court order, it can withhold or withdraw money from your term deposit and pay it as instructed. For instance, IRD might claim the money in connection with child support. Third party claims can also be made against a term deposit.

The bank may also exercise a right of set-off to repay any amounts you owe it. If the bank holds your term deposit as security against lending it can withhold repayment. Accounts can also be suspended if the bank suspects unlawful activities.

Several banks – ANZ, BNZ, The Co-operative Bank and SBS Bank – claim a right to withhold your term deposit if you breach any of their terms and conditions. However, this type of broad-ranging clause may fall foul of the ban on unfair terms in the Fair Trading Act. For example, it could be unfair for a bank to withhold your money for a minor breach. We think banks should review these terms.