Tax advantage of debt fixed maturity plans make it an attractive investment option
FMPs are closed-ended funds which invest in bonds and other securities. Though they don’t give assured returns, these usually match the yields of the bonds in their portfolios. “Given the type of bonds in the portfolio, investors could earn anywhere between 7.25% and 8%,” says Rupesh Bhansali, Head (Distribution), GEPL Capital. Portfolios with a higher allocation to AA rated bonds could earn 8%, while those with only AAA rated paper could earn 7.25-7.5%.
The big benefit is the lower tax rate on the income from FMPs longer than three years. While the interest earned on fixed deposits is added to the income of the investor and taxed at normal rates, the returns earned from FMPs longer than three years are treated as long-term capital gains and taxed at 20% with indexation.
How FMPs attract lower tax
Indexation reduces the tax on long-term capital gains.
“If you invest in a 1,140-day FMP before 31 March, you will actually be holding it for slightly longer than three years but will be eligible to claim the indexation benefit for four years,” says Prashant Maurya, Partner, Citrine Financial Advisors. The market is flooded with FMPs with tenures slightly longer than 1095 days. “There is a rush among HNIs to lock into these FMPs before 31 March,” says Ashish Shankar, Head Investment Advisory, Motilal Oswal Wealth Management.
Since the investment is made in 2017-18, but matures in 2021-22, the investor would be eligible for four years of indexation though his money remained invested for a little over three years.
However, FMPs are not without risks. They lack liquidity and getting out can be difficult. “Investors may sell these on the stock exchanges before the lock-in period ends, but usually these are either thinly traded or are traded at deep discounts,” says Maurya.
FMPs you can invest in
Source: Value Research
FMPs also have credit risk. “FMP returns will be hit if any security held in its portfolio faces a downgrade,” says Ankita Tanna Narse, founder, Oaktree Financial Advisors. Also, if interest rate starts going up, the investor who has locked in his or her money in an FMP might lose on the opportunity to earn a higher interest on investments.
Advisers ask investors to understand the indicative portfolio holdings and investment pattern of an FMP before investing in it. “It is not very difficult to gauge the portfolio quality. Study the indicative investment pattern and quality of portfolio before you choose one. It is mentioned in the Scheme Information Document,” says Narse.