Nov 26, 2008

FDs Vs FMPs: Which Is a Better Investment Option?

BOTH fixed maturity plans (FMPs) and fixed deposits (FDs) are debt instruments with a fixed time horizon and assured (in case of FMP - indicative but virtually assured) returns. However, FMPs go a step forward and combine safety and returns of fixed deposits with tax efficiency of mutual funds. The aim is to give a better post tax return than a FD.

FMPs at maturity generally tend to pay out returns as dividends which are taxed at lower rates (dividend distribution tax currently is 14.16%) than those for interest payments on FDs. Income from fixed deposits is added to your total income and taxed at the maximum marginal rate applicable to you (the highest tax bracket being 33.99%).

In case FMPs are held for more than a year, gains are considered as long term capital gains (LTCGs) (since FMPs are mutual funds) and eligible for concessional tax treatment i.e., taxed @ 10% (plus surcharge) without indexation or 20% (plus surcharge) with indexation. The indexation benefit allows cost to be adjusted for inflation; thus, reducing the capital gains to be taxed.

Furthermore, at the end of financial year i.e., during the month of February and March, mutual funds launch FMPs maturing after 370-400 days, offering double indexation benefits. Although such FMPs mature barely a year later, they cover two year end closings, hence the double indexation benefit. Therefore, you can gain from double indexation benefit by investing just before the end of a financial year and withdrawing it shortly after the end of the next financial year and thus making the returns virtually tax free.

One more benefit of FMPs which is often overlooked is that unlike FDs there is no TDS in case of FMPs.

Of course, on the basis of return parameter, FMPs are definitely better than FDs as they give better post tax returns viz-a-viz FDs. However, remember that the higher returns are accompanied by higher risks. In other words, tax advantage makes them superior to FDs but there is always a slight credit risk present (though as of now, there is no default). Furthermore, unlike FDs where the returns are guaranteed, FMPs offer indicative yield which means that there is always a possibility of actual returns deviating from those indicated at the time of investing.

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