What are The Benefits Of FMPs?

Aug 02, 2018 10:00 IST 655 views

A Fixed Maturity Plan (FMP) is a closed-ended fund that invests predominantly in debt instruments. Since it is a closed-ended fund, it is able to invest in instruments that precisely match with the tenure of the FMP in terms of asset maturity. This helps eliminate the interest rate risk or the risk of price depreciation almost entirely. This is more so in the current scenario when the interest rates are headed higher.

Here Are Some Key Benefits Of Investing In Fixed Maturity Plans (FMPs)

Fixed Maturity plans offer the safety and security of debt instruments. By default, debt securities are much safer and more stable compared to equities. For investors looking at stable returns and safety of principal, this is a good product. FMPs normally invest in highly rated instruments like government bonds, institutional debt, AAA rated debt etc. In such cases, the risk of default is much lower and that stability gets passed on to the investor.

A very important advantage of the FMP is that it virtually eliminates interest rate risk. When you are invested in an open-ended debt fund then any rise in interest rates will result in a fall in the value of the debt securities. This will result in NAV depreciation. However, since FMPs are closed-ended they are locked into fixed returns and hence there is no interest rate risk in FMPs. This makes it an ideal product in a rising interest rate scenario.

FMPs are more tax efficient compared to bank FDs and similar debt instruments. When you invest in bank FDs, the interest earned is taxed at your peak rate of tax. So if your tax rate applicable is 30% then you are taxed on your FD interest at 30.9% including the cess. In the case of FMPs, there are two options; you can either opt for the dividend plan or the growth plan. The dividend plan may not be too efficient as the dividend distribution tax (DDT) is around 29.12% including the surcharge and cess and is almost as high as in the case of bank FDs. However, a growth plan of FMP can be more efficient.

The tenure of the FMP matters a lot. If the tenure of the FMP is up to 3 years, it is treated as STCG. That means the capital gains will be taxed at your peak rate of 30.9% and hence there is no special advantage in the FMP, except that returns are higher than in the case of bank FDs. However, if the FM is held for more than 3 years, then it becomes long-term capital gains and will now be taxed at just 20% with the benefit of indexation. Let us look at why indexation becomes so important in the case of FMPs?

Understanding The Benefit Of Double Indexation In FMPs

One of the ways to play the FMP is through the benefit of double indexation. Many fund houses actually issue their FMPs around the end of a fiscal for a period of 1100 days and redeem their FMPs at the beginning of the fourth fiscal year to maximize the double indexation benefits. Here is how it works in practice.

Particulars

370 Day FMP

Double Indexation

Tax Benefits accrued

Date of FMP issue

March 29th 2014

Index Value on 29-3-2014

220

Date of Redemption

April 03rd 2017

Index Value on 03-4-2017

272

Tenure of the FMP

1100 days

Index Factor (272/220)

1.236

FMP purchase NAV

Rs.100.00

Indexed cost of Purchase

Rs.123.60

Annual Return

9.5%

Redemption Value

Rs.131.46

FMP Redemption NAV

Rs.131.46

Indexed Capital Gain

Rs.7.86

LTCG

Rs.31.46

LTCG at 20%

Rs.1.57

 

 

Effective Tax Rate

4.99%

 

 

Gains post LTCG tax

Rs.29.89

 

The big advantage that FMPs offer is that they can be double indexed by timing the issue and redemption. By holding for 5 days more than 3 years the investor gets the benefit of 4 years of indexation. Effectively, the tax rate for the investor is just 4.99%. That is where FMPs come in handy.

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