Fixed Deposits is the most preferred avenue of saving for Indian households (at least for the white money). These days, there is another investment avenue which is gaining a lot of attention – Fixed Maturity Plans (FMP). Most of us tend to ignore it, either due to misplaced notions about mutual funds or ignorance or fear of venturing into unknown. But, FMPs are slowly growing into a formidable alternative to FDs and are worth considering for your next investment. Here is why.
What are FMPs?
FMPs are the mutual fund houses’ answer to the guarantee and safety of FDs. FMPs are essentially debt mutual funds which are invested in instruments equal to the tenure of the mutual fund. For e.g. If the FMP is for 365 days, it will invest the money in instruments of a similar maturity.
FMPs manage this by being closed-end funds. i.e. they are open for investments only for a short period (say a week). Once the offer closes, it invests the total collection in debt instruments from banks and corporates and t-bills/bonds with maturity that coincides with the maturity of the FMP. At maturity of the FMP, you will receive your principal with interest (just like in an FD).
FMPs are available in various maturities, generally ranging from 30 days to 5 yrs.
What is the dividend option and growth option in FMPs?
These options are a way of classifying your returns.
In case you choose your FMP with the dividend option, the returns will be taxed at the dividend distribution tax (currently 13.84%).
If you choose the growth option and the FMP maturity is less than one year, the income will be taxed at your marginal tax rate.
If you choose the growth option and the FMP maturity is more than one year, you can avail of indexation benefits and taxes will apply accordingly. Read further to know more about indexation benefits.
What is indexation benefit in an FMP?
The indexation here means indexation for inflation. Government of India allows you to factor in cost of rising prices while calculating gains on FMPs (and other mutual fund investments). It releases a cost inflation index every year, for this purpose. Here is how indexation works:
Amount invested in Aug 2012: 10 lacs
Amount redeemed in Aug 2013: 12 Lacs
Cost Inflation Index in 2012: 852; Cost Inflation Index in 2013: 939
Inflation Rate:(939-852)/ 852 = 10%
Hence your principal (10 Lacs) adjusted for inflation becomes 10 Lacs * 10% = 11 lacs
Taxable amount = 12 lacs – 11 lacs = 1 lac while
Interest amount = 12 lacs – 10 lacs = 2 lacs
Thus, indexation benefit in this case reduced your taxable amount by 1 lac Rs.
Amazing. Isn’t it!!
Comparison of FMPs with FDs: