Fixed Maturity Plans are popularly known as FMP’s.
FMPs are close ended debt funds that have fixed maturity date and they invest in debt and money market instruments maturing on or before the date of maturity of the scheme.
These are equivalent of fixed deposit in the bank with a little difference that returns are indicative and not guaranteed. Since the mutual fund company knows what interest rate it will earn on its investment, it can provide indicative returns to the investors. Tenure of FMP can be as short as one month to as long as three years.
So why should one consider the FMPs? While such plans offer several advantages, the tax benefits stand out. Irrespective of the holding period, FMPs generate better post-tax yield. The length of the holding period matters, especially when one has to decide between growth and dividend options. Investors can go for the growth option if the holding period is more than a year and for the dividend option if the holding period is less than a year.
Mutual fund investors have the option of paying capital gains tax at 10.3% (without indexation) or at 20.6% (with indexation). Indexation helps offer compensation against the rising inflation and, in this case, one is allowed to increase the value of initial investment as per the cost inflation index provided by the Income Tax Department. On the assumption that the inflation is 6%, the capital gain after indexation works out to just 4%. Since the 20.6% capital gains tax is paid only on 4%, the effective is lesser, taking the post-tax yield up to 9.18%.
As per the current law, investors can claim double indexation benefit if the holding period is over three financial years. Consider the case of a 375-day FMP, which starts on 26 March 2012 and matures on 5 April 2013. Since it is spread over three financial years-2011-12 (investing year), 2012-13 (holding year) and 2013-14 (redemption year)-the indexation will be for two years (6%+6%). In this case, one can report a 2% long-term capital loss (instead of gain) and it can be set off against other long-term capital gains reducing the tax liability further. One can come across several FMPs with double indexation benefits in March.