Fixed Maturity Plans (FMP's) : Advantages

Come March and apart from equity-linked saving schemes, there's another mutual fund (MF) scheme in the tax-friendly genre that offers an attractive proposition to make money-fixed maturity plans (FMPs). As of now, there are several of them on offer . Most of these FMPs come with a tenor of one year, though a handful offer a tenor of three month to one month too.

For those in the highest tax bracket of 30.90%, FMPs make sense since the tax rate is just 10.30% if they are held for at least a year. For tenors of a year or more, opt for the growth option. Short duration FMP's of less than an year can be in dividend mode, since the dividends are tax free after a dividend distribution tax of 15% for individual investors.

FMPs are closed-end debt schemes that come with a specific tenor, typically three months to a year, or even about two years. These schemes invest in debt securities that mature just before or on the date of the scheme's maturity. In other words, a one-year FMP will invest in scrips that mature just before a year. Around the maturity date, it sells all its securities and pays back the money to its investors.

Since FMPs invest largely in CDs and commercial papers (CP; issued by companies), they benefit when the prevailing interest rates are high in the economy.
How to choose

Choosing an FMP at the right time can be quite a pain. Most FMPs open and shut for redemption within a few days. Names of FMPs can also sound complicated with two issuances separated by just a week and saddled with serial numbers.

Stay in touch with your Investment advisor: The best way to keep track of FMPs is to be in touch with your investment advisor or Wealth Manager. Ask for regular updates. Once you ascertain the time frame for investment, keep an eye on New Fund Offers (NFOs). Blinking at the right time can get you extra returns.

Which plan to choose?

FMPs are taxed like any other bond fund. If held for at least a year, you pay tax at the rate of 10.30% (including surcharge) without indexation or 20.60% with indexation. Compared with that, interest on bank fixed deposits are taxed at your income tax rates (30.90% if you are in the highest tax bracket). For tenors of a year or more, go for "growth" option. For tenors less than a year, opt for dividend plan.

Double indexation

There's a trick in the book that helps you save taxes on your FMP investments. Despite long-term capital gains tax on debt funds at 10% without indexation and 20% with indexation (depending on the option you choose), you can save taxes by choosing the indexation option, especially in FMPs launched towards the end of March and those that come with a tenor of little over a year, so that it covers two accounting years.

For instance, a 400-day FMP that closes on, say, 21 March 2011 would mature on 23 April 2012 and would cover two accounting years; 31 March 2011 and 31 March 2012.

On account of rising inflation-and the subsequent decrease in the value of money- the government allows the cost price of a financial instrument (in this case, your FMP) to be inflated, so that the profit (difference in selling price and cost price) gets narrowed down. For instance, the cost price of Rs1 lakh invested in an FMP today will become about Rs1.12 lakh at the time of maturity, assuming the cost inflation index goes up by 6% after 31 March 2011 and a further 6% after 31 March 2012.

Since the repurchase price of the FMP is Rs1.09 lakh (less than Rs1.12 lakh; the inflated cost price), your investment shows a loss on paper and hence you don't pay tax. Typically, FMPs launched during the last fortnight of March offer double indexation (covers two accounting years).

Do make use of such opportunities to maximize wealth