What are FMP Mutual funds and how they are tax efficient than bank FD?
Bank Fixed deposits have been favorable for many investors as they provide fixed returns. If you are in high tax bracket, the post tax returns would be very low. One of the answers to this is to invest in Fixed Maturity Plan (FMP) mutual funds. FMP’s are tax efficient investment options. In this article, I would detail about what are FMP mutual funds, its features, how does they work and how they are tax efficient options.
What are FMP Mutual funds?
Fixed Maturity Plan (FMP) mutual funds are those which are close ended mutual funds. These mutual funds are issued for a specific period say 30 days, 90 days, 180 days, 365 dys, 400 days, 2 years or 3 years. Once the period is over, the FMP mutual funds mature and the money is return back to investors along with returns earned on such mutual funds. FMP Mutual funds invest in fixed income options like government securities, corporate deposits, corporate bonds, short term securities etc.
How does FMP Mutual fund works?
FMP mutual funds are similar to debt mutual funds which invest in fixed income options. However FMP matures within the maturity date. E.g. if a FMP is issued for 365 days, it invests in income options where the maturity is within 365 days. Since this FMP mutual fund already knows the maturity period and where they invest, they would provide “indicative returns” while launching FMP mutual funds. These are only indicative returns and the returns are not guaranteed.
How FMP Mutual funds are taxed?
FMP mutual funds comes with two options, Dividend option and growth option.
FMP – Dividend option – Any dividend received from dividend mutual funds are tax free.
FMP – growth option – Returns received from selling of growth mutual funds within 1 year would be falling under short term capital gain and would be taxed as per individuals income tax slab. For FMP redeemed more than 1 year, you need to pay tax at 10% without indexation and 20% with indexation.
FMP Vs Bank FD – Comparison of their features
Returns: Bank FD returns are fixed and known upfront. On the other hand FMP mutual funds provide indicative returns, but they are not guaranteed.
Maturity: Bank FD’s have a fixed maturity date. They can be renewed after the maturity date. On the hand FMP’s have fixed maturity date and cannot be renewed.
Liquidity: Most of the banks are allowing to withdraw bank FD with small penalty. However FMP are listed in stock exchanges and would be available at steep discount if you want to sell. Hence, FMP’s are illiquid in nature.
Taxation: Bank FD’s returns taxed based on individual tax bracket. However FMP returns of over 1 year would be 10% without indexation and 20% with indexation. Below table would show how FMP’s are tax efficient compared to bank FD’s.
When FMP’s are open for subscription?
Mutual funds flood markets with Fixed Maturity Plan (FMP) during Feb/Mar period. The main reason is they would issue 400 or 450 days maturity period FMP’s which matures in second financial year which gives good tax benefit. E.g. FMP’s issued on 1-Mar-13 (FY 2012-13) with 400 days maturity period would mature on 5-Apr-2014 (FY 2014-15). An individual would get double indexation benefit as the investment period has completed two financial years and the tax would be almost zero or very less. However investors should read the prospectus and understand the risks involved in this. Some FMP's indicate that they would invest say 30% in equity which would be somewhat risky. Knowing such risks upfront would help them in choosing righ FMP mutual fund which is suitable to them.
To whom FMP’s are best suitable for?
These are best suitable for investors who are in highest tax bracket. The post tax returns for such investors would be high comparing to other fixed income options like bank FD’s. If such investors can also invest during the period where they can get double indexation benefit, it would be double dhamaka and the tax would be almost zero or tax would be very less.
Conclusion: FMP Mutual funds offer 8% to 9% returns which is comparable with bank FD’s. However these are tax efficient. High tax bracket individuals should diversify part of their portfolio to FMP’s instead of investing in bank FD’s to get higher post tax returns.
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What are FMP Mutual funds and how they are tax efficient than bank FD
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