Fixed maturity plans (FMPs), out of favour in the last few years, are back in the news. Reason: Their assets under management – Rs 1.2 lakh crore – are at a three-year high. And, with interest rates on the rise, returns from these instruments will continue to improve.
Retail investors should take a call, based not just on returns but also on their holding capacity. While FMPs give higher returns and more tax benefits than fixed deposits, they suffer from certain restrictions. For one, they will be listed on the stock exchanges. This implies the investors will only be able to exit by selling at the exchanges. This reduces the liquidity of the product, because in the absence of a strong secondary market, one may have to sell at a discount, if exiting prematurely. Also, fund houses can no longer give ‘indicative portfolios’ and ‘indicative yields’.
These guidelines were introduced by the market regulator, Securities and Exchange Board of India (Sebi), after almost RS 1 lakh crore was withdrawn by investors in October 2008, because of fears that fund houses were putting money in risky sectors.
Of course, investors are still given an idea of the indicative return. However, it is done in an informal manner. For instance, one-year FMPs that only have certificates of deposit (CDs) are offering 9.3-9.4 per cent. FMPs that include other instruments are offering 9.5 per cent.
FMPs are generally for periods between three months and three years. They invest in various kinds of financial securities, like CDs issued by banks and commercial papers (CPs) issued by companies.
The tax efficiency of FMPs comes from the fact that the investors can get double indexation benefits. When compared to bank fixed deposits, FMPs may not appear very attractive in terms of returns. Interest income from bank deposits is added to your income and taxed on the slab you fall under.
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Returns from FMPs maturing slightly over a year, on the other hand, will get indexation benefits of two years – of the investing and maturing years. Due to the two indexation benefits, the capital gains are lower. After that, they are taxed at the rate of 10 per cent without indexation and 20 per cent with indexation.
As a result, when investing for a year or more, go for the growth option, and for less than one year, go for the dividend plan. This helps save tax. With one-year FMPs, you will be taxed at 10 per cent flat (no indexation), and when invested for less than a year, dividend is taxed in the fund house. Before investing, remember that you will have to hold it for the entire tenure.