ALTERNATIVE TO BANK FIXED DEPOSITS
Fixed Maturity Plans (FMP) offered by mutual funds, are primarily close-ended debt funds with a fixed tenure. The tenures of these schemes are usually synchronized with the average maturity period of their underlying investment portfolio. Hence, an FMP investment portfolio generally comprises various debt papers such as money market instruments, corporate bonds, government securities, etc which mature a little before the plan matures.
The fixed tenure that characterizes FMPs is what makes these comparable to bank fixed deposits.
FMP v/s Bank Fixed Deposits
FMP have a fixed term but holding can be redeemed before the maturity date at a cost. The investor has to bear an exit load, which, depending on the plan and the time-frame of investment, can range from 0.5 percent to 4 percent.
Bank fixed deposits allow a great deal of liquidity since the depositor can undertake premature withdrawals. In case of a premature withdrawal interest is received at the rate applicable for the term for which the deposit is maintained. For instance if the depositor wishes to prematurely withdraw a 3-year deposit, after the completion of only 1 year of the deposit term, then interest received will be at the rate that is applicable to a one year deposit.
FMP mutual funds are subject to two types of risks â€“ interest rate risk and credit risk. FMP are designed to effectively address each of these risks. The interest rate risk is relatively low as FMP hold the underlying debt investment till maturity. This ensures that they lock-in-their invested corpus at specific yields, so changes in interest rates are of little consequences to them. FMP invest in instruments with good credibility, which enables them to minimize the level of credit risk involved and deliver capital preservation.
Bank fixed deposits are insured with the Deposit insurance and Credit Guarantee corporation (DICGC) up to an amount of Rs 1 lakh per deposit which further enhance the safety of these instruments.
Presently, the term of FMP on offer generally ranges from 60 days to 36 months.
Bank fixed deposits can be placed for flexible time periods. The minimum and maximum tenure of these deposits varies from bank to bank. Generally, the minimum term of such deposits is 7 days and maximum is 10 years.
Tax implications on income earned:
FMP: If the dividend option is chosen, then the dividend income earned is tax-free in the hands of the investor. However, the scheme bears a dividend distribution tax which is 14.025 % inclusive of surcharge and education cess in the case of dividends distributed to individuals. If investment is redeemed in less than one year, then the gains are termed as â€˜short term capitalâ€™. The tax rate applicable on these gains is according to personal income tax rate. If the investment is redeemed after 1 year, then the gains are termed as â€˜long term capital gainsâ€™. The tax rate applicable on these gains is 10% without indexation or 20% with indexation, whichever is lower.
Bank fixed deposits: Irrespective of the time for which funds lie in this account, the interest income earned attracts tax at the personal income tax rate applicable to the depositor.
To sum up, Bank fixed deposits come with a tax benefit on the amount invested applicable to only those wherein the deposit term is 5 years or more. Since the term of FMP on offer generally ranges between 60 days to 36 months, these should be compared only with bank fixed deposits of a similar term, which do not come with a tax benefit. Additionally, due to the different tax implications of the income earned from both these avenues the post-tax returns would be significantly higher in the case of FMP. On a post-tax basis FMP aim to provide a far superior return than bank fixed deposits, with the added advantage of a strong, diversified portfolio of well researched credits.