About FMP (Fixed maturity Plan)
Fixed maturity plans (FMPs) offer investors the twin benefits of investment and tax savings. Not so popular among investors, FMPs are a fixed tenure, closed-ended mutual fund (MF) scheme with characteristics similar to that of a bank fixed deposit (FD) except taxing factor.
Under an FMP, funds are invested at the time of initial offer for a fixed time and can be redeemed only at the end of the lock-in period. Usually misunderstood to be equity linked schemes, FMPs are, in fact, pure-play debt funds. Funds under FMPs are invested in debt and money market instruments including corporate bonds, commercial papers and certificates of deposit, etc and in government securities as well.
Will the returns go up?
Experts are of the view that these returns will go up in the near future as they expect the RBI to raise interest rates further to tighten the rising inflation. This may increase the returns from CDs and CPs that FMPs invest in, thus pushing up FMPs' returns in turn.
What is indexation benefit?
The finance minister has been generous enough to recognize that inflation erodes the real value of any investment. So every year, he comes out with an inflation index based on the prevailing rate of inflation. The cost of investment is indexed by multiplying the index of the year of maturity and divided by the inflation index prevailing on the year of investment. If you have arrived at an indexed cost, then the long-term capital gain is taxed at 22.44 per cent and if you do not opt for the indexed cost, then the tax is 11.22 per cent.
FMPs are classified under the debt scheme category and enjoy certain tax benefits, such as:
· Dividend in the hands of the investor is tax-free. But the mutual fund has to deduct a dividend distribution tax of 14.025 per cent in the case of individuals and Hindu Undivided Families (HUFs), and 22.44 per cent in the case of corporate.
· Long-term capital gains (investment of more than a year) enjoy indexation benefit.
· Short-term capital gains are added to the income of the investor and taxed as per his/her slab, whereas the interest on a bank deposit (except where special 80C approved) is added to the income of the investor and taxed as per his/her slab.
The following table shows how the FMP will generate returns based on Indexation
375 days FMP or a 375 days FD
How safe are FMP?
FMPs are safe.
"If an FMP is investing only in bank CDs, then there is no risk at all.
"Most MFs maintain that their FMP products invest largely in bank CDs. After the past experience, financial securities issued by real estate companies are being avoided largely. However, there could always be the odd FMP which could take exposure to infrastructure and real estate paper to jack up the yields. In this respect, investors would be better off sticking to offers from reputed funds even if the return is marginally lesser.
Difficult to get out
What investors should remember is that it is very difficult to get out of an FMP before it matures.
Earlier, if an investor wanted to come out of an FMP investment, he could redeem his investment with the mutual fund by paying an exit load of around 2% of the net asset value. Now, a mutual fund is not allowed to redeem an FMP investment.
These schemes are listed on the stock exchange and the investor can sell his units to any other investor willing to buy.
FMPs are close-ended mutual fund debt schemes that have a predetermined maturity date. They invest in government securities, corporate debt and money market instruments, and aim at generating steady returns over a fixed period. They protect investors against market fluctuations. You cannot get premature redemption during the investment period and need to stay invested till maturity. FMPs are exchange-listed and the units can be sold on the exchanges.
Fixed maturity plans (FMP) offered by mutual funds have become fairly popular among investors in the recent past.
Also due to increasing interest rates, FMPs have started offering superior tax-adjusted returns to investors. In fact, according to investment experts, an FMP of little over a year can offer a per-tax return of close to 10%.
Investment Duration -
Investment in FMP can be from 90 days to 3 years.
FMPs usually invest in certificate of deposits (CDs), commercial papers (CPs), money market instruments, corporate bonds and sometimes even in bank fixed deposits.
These FMP NFOs are generally open for 2 to 3 days and are marketed to corporate and high net-worth individuals. The minimum investment is usually Rs 5,000, so a retail investor can comfortably invest too.
They are closed-ended in nature, which means that once the NFO (new fund offer) closes, the scheme cannot accept any further investment.
Depending on the tenure of the FMP, the fund manager invests in a combination of the above-mentioned instruments of similar maturity. Say if the FMP is for a year, then the fund manager invests in paper maturing in one year.
Returns on FMPs
Until sometime back, mutual funds were allowed to give out indicative returns on FMPs. This gave investors an idea about the kind of returns they could expect but SEBI (The Securities and Exchange Board of India) the market regulator, has now banned the practice. However, unofficially, most mutual funds do give out indicative returns.
The expected return on an FMP largely depends on the returns being offered by the financial securities they have invest in, i.e., CDs and CPs.
The current returns for 90-day CDs are about 9.4% and the one-year return is around 10%. Taking into account the expenses, the pre-tax return on an FMP could be 0.2% to 0.4% less. This means, most one-year FMPs now offer around 9.6% to 9.8% return, whereas 90-day FMPs offer around 9% to 9.2%. "Returns are around 9.6% to 9.7% for an FMP fully invested in bank CDs.
The prevalent yield minus the expense ratio, which varies from 0.25 to 1 per cent, will be the indicative return which can be expected from the FMP.
The expense ratio is mentioned in the offer document. The yield can be indicated fairly accurately because these schemes are open only for a short while.
But there is no liquidity in these schemes, ie, if you are looking to sell, there are no buyers. "The liquidity is poor.
Given this, investors should invest in FMPs only if they do not need the money any time soon. "Liquidity is an issue with FMPs as it depends on someone buying them from you. FMPs are not really liquid from a practical standpoint. So invest in FMPs to only those who can hold them till maturity.
Comparison between Fixed Deposit and FMP
Are FMP’s as safe as FD’s?
FMP’s are not absolutely safe as an investment option and have a probability of default and credit risk since money collected through FMPs is invested in companies and there is a probability of default in payment by such companies. To offset this risk, FMPs offer slightly higher returns than the safer fixed deposits. However, as in the case of fixed deposits, one cannot be sure of exact returns at the time of investment.
In a rising interest rate scenario, FMPs are seen as best investment tools. They are better investment options than bank fixed deposits (FD) as they offer higher after tax returns with minimal extra risk. Common misconception here generally is that both FMP’s and FD’s give guaranteed returns. While it is true for the latter, it doesn’t hold true for the former. Investors know in advance that returns they will get but with FMP’s these are indicative returns.
FMP’s are close ended debt funds with a fixed maturity but these are always a possibility that their returns can deviate from what has been indicated. In case of FD’s returns are fixed. Investor will exactly get what they have been promised. FMP’s yield varies only marginally. The yields vary because for the same tenure the yields on debt instruments are usually in range which is why FMP’s of similar tenure will have comparable yields. The difference in yields between two FMP’s arises out of risk taken on in the portfolio - a FMP having top rated instruments in its portfolio would deliver comparatively less than FMP with lower rated papers. Higher returns means that the fund manager has been taking on more credit risk in the portfolio.
Which one is more tax efficient - FMP’s or FD’s?
Significant issue to discuss is tax treatment in case of FD’s and FMP’s. The interest incomes from FD’s are added to investor’s income and taxed at is applicable tax slab. Income from FD’s is categorized as ‘Income from other sources’ under the income tax laws. In case of FMP’s, tax implication depends on the investment option - Dividend or Growth. Under the dividend option, investors have to bear dividend distribution tax whereas under growth options returned are treated as capital gains (short or long term depending on tenure of investments). Dividend option is best suited for investors who fall under higher tax bracket (if the investment horizon is less than a year). Though the dividend received is tax free in the hands of investors, a Dividend Distribution Tax (DDT) of 14.165% is levied by the mutual funds and deducted from investors’ proceeds before pay out.
For FMPs of more than one-year tenure, one needs to pay tax at 10% or 20% depending on whether one chooses to have indexation. Inflation erodes the real value of any investment. So every year, an inflation index based on the prevailing rate of inflation is announced. The cost of investment is indexed by multiplying the index of the year of maturity and divided by the inflation index prevailing in the year of investment. If you have arrived at an indexed cost, then the long-term capital gain is taxed at 22.66% and if you do not opt for the indexed cost, then the tax is 11.33% of the gains.
Interest income from fixed deposits, irrespective of tenure, is treated as income from other sources and normal tax slabs apply. So in case an investor is in the 30% tax slab, he will be required to pay tax @30% on the interest earned through fixed deposits. But the same investor will have to pay only 10% or 20% on an FMP with tenure of more than one year.
An investor in an FMP with tenure of over a year who opts for growth option to take gains as capital appreciation will attract a tax rate of 10% or 20 %( depending on whether or not indexation is applicable). As against this, interest on bank’s Fixed Deposit of similar tenure might be taxed at 30%. In case of short-term capital tax, it is similar to interest income from bank fixed deposits. The returns are added to the income of the investor and taxed as per his/her slab.
FMPs of longer-term maturities spanning over more than two financial years also offer better tax efficiency through double indexation benefits. For instance, if you buy an FMP of 14 months in February 2010, scheme will mature in April, 2011. In this case, the investor will get inflation indexation benefits for the years 2009-10 and 2011-12.
So which one is more beneficial - The answer is FMP’s. Thanks to indexation benefits (explained in above table), FMP’s are more tax efficient as indexation lowers tax liability. FMP’s are more tax efficient while FD’s are safer. This is true to certain extent. But FD’s have their share of risk as well. The credit rating of an FD is an indicator of degree of risk associated with it. For instance a rating of ‘AAA/FAAA’ offers the highest value of safety. So an FD carrying a credit rating lower than this carries higher risk. In case of FMP’s, one should ensure that FMPs should be from a reputed fund house which invests in good corporate paper. In 2008, many FMPs invested in real estate companies and faced problems when the downturn started. Hence one should check on fund house before selecting the FMP. For FMPs, they are tax-efficient and yield favorable returns. However, they offer no guaranteed returns (unlike fixed deposits) and ample liquidity.
Given the present credit market tightness, fund houses launch more FMPs. Investing in short term FMPs is generally advised at this point of time. They can be an excellent investment for investors who clearly understand the risks associated with them.
In nutshell, both FD’s and FMP’s are viable investment options if you are looking to fetch competitive returns at minimum risks. Which one you choose depends on your risk profile and investment objective among other factors. While FMP’s may appeal to investors willing to take little risk for that extra return , FD’s will find favor with investors who are satisfied with lower but assured returns.
Fixed Maturity Plan (FMP) and Fixed Deposit
90 days FMP or 90 days FD
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