Monday 13 June 2016

Understanding Fixed Maturity Plan (FMP) , Taxation and Benefits

Fixed Maturity Plan : Your Friendly Alternate to Traditional Investment


Most of us like traditional investments mainly for two reasons:
  • It offers assured returns 
  • It has a date of maturity
You are comfortable at knowing the value of your savings at maturity accordingly you can plan for your expenses or may be other investments better

What if you have an investment solution that seeks to provide :
  • a specific maturity date 
  • an exposure to high quality bonds 
  • risk adjusted returns along with tax benefit 

 

What is Fixed Maturity Plan : 


Fixed Maturity Plan matures at a pre specified period and it generally invest in fixed income securities like Non-Convertible Debentures(NCDs), Corporate/Government Bonds, Treasury Bills (T-bills), Commercial Papers(CPs), Certificates of Deposit (CDs), Bank FDs and other money market instruments. 
FMP are closed ended mutual fund scheme. FMP invests only in instruments whose duration is similar to its own term i.e., it aligns its term with that of its underlying assets. For example, recent NFO of ICICI Prudential Fixed Maturity Plan - Series 79 - 1126 Days - Plan C will invest in instruments that mature for 1126 days or before that. 

Why a Fixed Maturity Plan?

 

  • Fixed Maturity Plans aim is to offer risk adjusted returns along with tax benefits.
  • Currently debt security yields are at elevated levels in the 1-3 year space. It could be a good time to lock into high yield debt issuance of various issuers and hold them till maturity to benefit from the prevailing high interest rates.
  • While investing in such securities, there is an endeavor to align their maturity with that of the plan to manage the interest rate risk. For instance, an FMP of a three-year maturity will invest only in securities that mature on or before three years.
  • Because of the size, the fund might invest in securities which are usually not available to retail investors. These securities might offer various benefits such as better credit quality.
  • Moreover, the returns from FMP have a tax advantage. This may vary from investor to investor and is subject to taxation laws. This tax advantage makes FMP an efficient investment choice

Tax Advantages of FMP vs Bank Fixed Deposits


FMP has an advantage when compared to similar investments like Fixed Deposits (FDs). In FDs, Interest earned is added to your income and taxed at your income tax rate. Interest from FD is categorized as "Income from other sources" as per the Income Tax Laws.  In the case of FMP, tax implication depends on the investment option chosen Dividend or Growth

Which option to choose ?


Dividend  Option : Dividends  in  FMPs  are  tax  free  in  hands  of  investors but Mutual  Fund companies  have  to  pay  a 28.33% Dividend  Distribution  Tax  (DDT)  including surcharge and cess and  30%  plus  surcharge  and  cess  for  others  (33.99%)  before distributing it to you as investors

Growth Option: If you opt for Growth option, it is subject to Capital Gains Tax. Short Term Capital Gains (if units are held for 36 months or less)  are taxed as per the Income Tax Slab Rate of investors. For Long Term Capital Gains (if units are held for more than 36 months) are taxed at 10% without indexation or 20% with indexation. The indexation benefit inflates the cost of purchase lowering long term gains tax liability, which is not the case of FD.

The tenure of the holding period matters, when one has to decide between growth and dividend options. You can go for the growth option if the holding period is more than a 3 years and for the dividend option if the holding period is less than 1 year


The reason is that gains from investment in Mutual Funds, if redeemed after 3 year in debt schemes, are considered
long-term capital gains. In the case of long-term capital gain, the investor is given the option of choosing between

  • 20% tax rate with indexation benefit, and 
  • 10% tax rate without the benefit of indexation
Before discussing the benefits of indexation, let’s first understand the concept. Normally, for calculating capital gains, we reduce the cost from the sale value. For calculating long-term capital gains, the amount invested is multiplied by the inflation multiple (Inflation Index for Redemption Year/Inflation Index for Investment Year) and then this indexed cost is subtracted from the amount realized at redemption. The extent of capital gains gets reduced,and so does the tax liability.
Below table illustrates the returns of Fixed Deposit vs Fixed Maturity Plan

Details Fixed Deposit FMP
Amount Invested (A)100000100000
Month & Investment Year Feb-12Feb-12
Rate of Return 9.50%9.50%
Holding Period36 Months36 Months
Month & Redemption Year Feb-15Feb-15
Amount at Maturity 131293131293
Gain 3129331293
Index Cost NA130446
Capital Gain 31293847
Tax Rate 30.90%20.60%
Tax Payable 9670175
Post Tax return2162331118

In our example above Cost Inflation Index (CII) for year of redemption (2014-15) is 1024 and year of purcahse (2011-12) is 785. The indexed cost of purchase = (A*1024/785)
 

Highest bracket of tax rate has been taken based on current IT slabs.

It is difficult to redeem Fixed Maturity Plans before the maturity or final date of redemption. Investors looking for redemption before maturity have to sell the units on the stock exchange. As per guidelines, all FMP schemes are listed on the stock exchanges however; trading is rarely done on the units.


PPS: If you think this page and blog will be useful to any of your friends please spread the word. A good way to start is to share this page on your social circle using floating social share bar on the left

Mutual Funds & Insurance Related Articles :-

Benefits of Systematic Investment Plan
What is Systematic Transfer Plan and How it works ? 
Advantages of Equity Linked Savings Schemes
Top 3 Mutual Funds to Invest in 2016 for Long Term
How Much Insurance Do I Need ?
How to Select Mutual Fund for Portfolio ?

How to Budget your money with 40/30/30 Rule ?
Mutual Fund Versus ULIP 

Why Term Insurance Policy is required till 60 years ?

Equities related article :
Risk Management in Broking House for You as Investor
Understand Your Daily Margin Statement
What is Power of Attorney in Online Trading?

Futures & Options related article :
Futures Trading Terminologies
What is Futures Trading?
What is Derivatives ?
What are Forward Contracts ?
Advantages & Disadvantages of Futures Trading ?
Guide to Options Trading
Long Call - Bullish Trading Strategies
Long Put
Short Call - Bearish Strategies
Sell Put - Bullish Strategies
Buy Straddle Option
Short Straddle Option
Synthetic Long Call
Synthetic Long Put
Synthetic Long Futures
Synthetic Long Futures
Bull Put Spread

In case of any further explanation you can reach me on vipuls1979@gmail.com or tweet me  @vipuls1979

Disclaimer  :-

The Article is only for information purposes and Vipul Shah (https://investkiyakya.blogspot.com) is not providing any professional/investment advice through it. The article does not constitute or is not intended to constitute an offer to buy or sell, or a solicitation to an offer to buy or sell financial products, units or securities. https://investkiyakya.blogspot.com disclaims warranty of any kind, whether express or implied, as to any matter/content contained in this article, including without limitation the implied warranties of merchantability and fitness for a particular purpose. https://investkiyakya.blogspot.com and its subsidiaries / affiliates / sponsors / trustee or their officers, employees, personnel, directors will not be responsible for any direct/indirect loss or liability incurred by the user as a consequence of his or any other person on his behalf taking any investment decisions based on the contents of this guide. Use of this article is at the user’s own risk. The user must make his own investment decisions based on his specific investment objective and financial position and using such independent advisors as he believes necessary. https://investkiyakya.blogspot.com does not warrant completeness or accuracy of any information published in this guide. All intellectual property rights emerging from this article are and shall remain with https://investkiyakya.blogspot.com. This article is for your personal use and you shall not resell, copy, or redistribute this article , or use it for any commercial purpose. All names and situations depicted in the article are purely fictional and serve the purpose of illustration only. Any resemblance between the illustrations and any persons living or dead is purely coincidental.

No comments:

Post a Comment