1. What is an FMP?
Fixed Maturity Plans or, in Short, FMPs (may also be called as FTP, FTIF etc.) are debt schemes with a fixed maturity, launched by mutual funds. They run for a fixed period of time that could range from one month to as long as three years or more. The objective of an FMP is to generate a return over a fixed maturity period. FMPs invest in fixed income securities like money market instruments government securities, corporate bonds, certificate of deposits (CDs), commercial papers (CPs), and bank fixed deposits (FDs) etc. which mature in line with the tenure of the fund. Since the instruments are held to maturity, there is no risk of the security being affected by interest rate movements.
2. What are the different types of FMPs?
FMPs can be differentiated based on
a) Composition of the portfolio – The FMP portfolio can be made up of distinctly asset type certificate of Deposits, Commercial papers etc.
b) Maturity period – FMPs can be classified into monthly plans (tenure of one month), Quarterly plans (tenure of three months), Half yearly plans (tenure of six months), yearly plans (tenure of one year) etc.
c) There are also various options – Dividend option, dividend reinvestment option and growth option.
3. Who should invest in FMPs?
FMPs are suitable for
• Investors who seek safe avenues for investment and in the process keep money in fixed deposits (FDs) with bank. They can tax efficient returns based on current tax laws#
• Investors who want to park money for a fixed period of time in relatively safe instruments giving returns, with a view to meeting certain goals in the near future.
Even aggressive investors who normally prefer equity investments should invest a part of their funds in FMPs, as one needs to have a proper asset allocation in place to achieve their goals. FMPs offer stability to the investment portfolio.
4. Why FMPs are attractive in the present investment environment?
FMPs are attractive for investors who look for a return and investors who require their funds back after a certain period.
In the scenario when interest rates are high it provides good opportunity to lock in investment at relatively higher yields. While long term debt funds are susceptible to interest rate movements, FMPs by the very nature of their structure offer a good cushion against interest rate movement.
5. How FMPs are similar to and different from Bank FDs?
FMPs are similar to a Bank FDs by the fact that both have fixed tenures and the returns of FMPs Though not fixed like Bank FDs and can be estimated at the inception of funds. FMPs are better than Bank FDs by the fact that they may relatively offer higher yields & a better post-tax return based on current tax laws, and macro-economic environment.
6. How FMPs are able to offer tax efficient returns to the investor?
The magic lies in the tax treatment of FMPs. FMPs being debt products offered by mutual funds enjoy different, favourable tax treatments as compared to bank FDs based on current tax laws. In the case of a bank FD, although there is an assurance of returns, the returns in the form of interest are liable to tax at the normal tax rates (for the higher tax bracket the tax rate is 33.99%). Moreover there is also a deduction of tax at source if the interest from a bank
FD exceed Rs.10,000/- in a year. In case of FMPs the return can be in the form of dividend or capital appreciation depending upon the option of the investor. Dividend is currently tax free in the hands of the investor while the fund has to incur a Dividend Distribution Tax of 13.5188% (for individuals and HUFs) and 32.4450% (in the case of Corporates). In case of investments for more than a year and under growth option, long term capital gains (LTCG) tax at 11.33% (without indexation benefit) and 22.66% (with indexation benefit) is applicable. Please consult your tax advisor before investing.
7. What are the risks in investing in FMPs?
• Credit Risk- In the case of FMPs , Credit Risk being the risk of default of the issuer of the security is minimal as the money is generally invested in risk free or highly rated fixed income securities.
• Interest Rate Risk- In the case of FMPs interest rate which is the possibility of the scheme getting affected by changing interest rates gets nullified as securities, are generally held till maturity of the plan. Hence the returns and investors staying in the scheme till maturity are not affected by market fluctuations and can hope to realize the yield which they have been looking for when investing in the scheme.
• Liquidity Risk- In the case of FMPs, liquidity risk being the risk of not being able to get funds back when needed is minimal as the investor knows at the time of investment the tenure of the scheme and can invest the funds for the fixed tenure with returns. However should the need arise; the investor can exit the scheme by selling his allotted units of FMPs on the respective stock exchange where it is listed.
FMPS aims to minimize most of the risks by the very nature of their structure and investment concept.
Choice of optimum to reduce the tax liability in case of FMPs **
• If the investor in the maximum Tax Bracket invests in an FMP with a maturity period of less than a year, then he/she may opt for dividend option to reduce tax liability. This is because under dividend option to reduce tax liability. This is because under dividend option, the dividend payout will be subject to Dividend Distribution Tax-13.5188% for individual & HUFs investors and 32.4650% for Corporates which is lower than the maximum income Tax Rates.
• If the investor chooses growth option under an FMP of more than a year, the investor can either pay tax at 20% on the capital gains with indexation of cost or 10% without indexation. If rate of inflation is substantially higher then indexation would be beneficial otherwise payment of tax without indexation may be more beneficial.
• In Case of FMPs of more than one year, choice of growth option is advantageous in comparison to dividend option from the point of view of tax.
• Under FMPs where multiple indexation benefits can be availed, (dependent on tenure of the FMP) the tax incidence calculation will be done with indexation benefits i.e. 22.66% on LTCG with indexation.
• Indexation benefits are not available under other avenues of investments like Bank FDs. Returns from investments like NSC are fully taxable and investments and returns in Post Office MIS do not carry tax benefits.