FDs or FMPs? Which option scores over?

An FMP and FD have similar features of fixed tenor and indicative returns. However, FMPs bring along greater tax efficiency. Here’s taking a look…

Fixed Deposits (FDs), for long, have been the key investment cum savings tool for the majority in India. You got a lump sum amount, and the next thing you would do is head towards the nearest bank, check the existing interest rates and park the money in an FD account. You were assured that your principal amount is safe and you would get fixed returns on your money. But that was some years ago. With the entry of mutual funds, an investor today is spoilt for choices.

What’s more, there are mutual fund products, such as Fixed Maturity Plans (FMPs) that not only give an indicative return over a fixed tenor, but are also highly tax efficient, thus offering a better ‘post tax return’ than FDs. In addition, FMPs also offer double indexation benefits.

What is an FMP?

FMPs are debt schemes, where the money is invested in fixed income securities like certificate of deposits (CDs), corporate bonds, commercial papers (CPs), money market instruments etc. The maturity term for FMPs can vary from 30 days to 3 years or even longer. Fixed maturity schemes are close-ended, which means you can subscribe to them only during the New Fund Offer (NFO) period. In short, FMPs are the equivalent of a fixed deposit in a bank, with the exception that the maturity amount in an FMP is indicative. Mutual fund companies are not allowed by the regulatory board to claim any guaranteed returns and therefore they can only give you indicative returns.

How FMPs earn better returns than FDs?

FMPs earn better returns than FDs because of the differential tax treatment meted out to them. The differential tax treatment ensures that the net yield of FMPs for individuals falling in the higher tax brackets is greater than FDs. This is because interest earned on an FD is treated as other income and hence, taxed at regular personal tax rates. So, for a person in the highest tax bracket (income more than Rs 10 lakh) the tax rate would be 33.66 per cent.  On the other hand, tax rates for FMPs are different. Following are the tax implications for FMPs:

·        Dividend received is tax free in the hands of investors. However, a Dividend Distribution Tax (DDT) of 14.165 per cent is levied on the mutual fund company.

·        Long-term capital gains (investment more than 365 days) enjoy indexation benefit.

·        Short-term capital gains (investment less than 365 days) are added to the income of the investor and taxed according to his personal tax rate. 

The illustration in the table below shows how the post tax return in FMPs is higher than that offered by FDs.

Note: For the sake of simplicity, it has been assumed that the FMP has distributed the entire yield as dividend. The DDT is deducted on the gross yield. In actual practice, the returns on the FMP-dividend would be slightly higher than indicated.

In case the maturity term of the FMP is more than a year, the growth option yields more because of the indexation benefit. To benefit from indexation, FMPs with maturity term more than a year structure the maturity term in such a way that you earn double indexation benefits- one for the year of purchase and another for the year of redemption.

In conclusion

FMPs score over FDs in net yield and therefore, are an attractive option for investors who have a fixed investment horizon and would like to know the approximate returns at the time of investment.