FMP: Taxation and FD Comparison

by Manshu on April 19, 2011

in Mutual Funds

FMP (Fixed Maturity Plans) are the biggest category of mutual funds in India, and when this topic was suggested – my first thought was why did it take so long for it to appear here.

FMP: Close Ended Mutual Funds

FMPs are close ended mutual funds and have gained in popularity due to their relatively secure nature and tax advantage when compared with a FD (fixed deposit).

They are close ended so you can only invest in them during the NFO, and redeem them only on maturity.

They are relatively safe but like other mutual funds – their returns are not guaranteed (or even the principal), and unlike a bank fixed deposit where you know how much interest you will earn – you don’t know how much your FMP will return. You can get an idea based on how other funds have performed, but the fund itself doesn’t tell you much you will earn.

FMP Taxation

Fund companies normally issue a lot of FMPs that are slightly over a year – like 368 days, 370 days etc. so that it enjoys the benefit of lower long term capital gain taxation.

Under the current regime – you can even take advantage of double indexation benefit for calculating long term capital gains if a FMP is issued such that it is issued in say March 2011, and redeemed in April 2012: 13 months in all but they are spread over 2 financial years.

I understand that this will be stopped with the DTC (Direct Tax Code), and since we’re already past March – it’s something that you can’t benefit from right now.

However, if you’re in the top tax bracket – FMP taxation still works out better for you when compared with a fixed deposit.

In a FMP you pay long term capital gains gains at either a rate of 10% without indexation or 20% with indexation (whichever is lower) which is better than interest on fixed deposit that’s taxed at your tax bracket which is upwards of 30% if you’re in the top bracket.

Hemant has written a detailed post about FMP vs Fixed Deposits where he’s shown numbers as well, so you can look at his post to see how the calculation works out.

FMP or FDs

It’s the tax advantage that tips the scales in favor of FMP, and people who are in the highest tax bracket can advantage from it. However, there are no free lunches and what you gain in taxes you could end up by way of lower return since a FMP can’t indicate how much return you’re likely to get, and you may end up getting stuck with a lemon.

You could compare past performance and do all that jazz, but there’s still a chance that the one FMP you chose to invest in performed worse than the others – so appreciate that risk while investing in them.

Here are some other differences between FMPs and FDs.

FMP vs FD

FMP vs FD

 

FMP NAVs and Asset Composition

Fund companies declare the NAV of their respective FMPs, and you can find these NAVs on their website, and they also declare half yearly results which has a list of the assets they own. This may not make much sense to regular investors though because they are usually names of banks with the CDs they own, and unless you’re very well versed with the bank bond market you can’t really tell one from the other.

Bottomline

In my opinion – people in the lower tax brackets are probably better off sticking with safer instruments like high interest rate fixed deposits, or Post Office Monthly Income Schemes that generate a decent return and offer peace of mind as well, but other folks who stand to gain more can definitely explore this option.

 

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