Fixed Maturity Plans(FMPs) are closed-end debt funds that are quite popular and useful. These FMPs, as they are called, are launched on a specific date for a specific period that can range from 1 month to 5 years.
FMPs are an excellent alternative to bank fixed deposits. They generally offer higher returns, especially because they are much more tax-efficient. This is because FMPs are taxed as capital gains while bank FDs are just added to the investors’ normal income.
Following examples will help you better understand how it works:
Say you deposited Rs.1,00,000 in bank Fixed Deposit on 10th November 2010. Interest Rate be 9% per annum. Interest accumulated at the end of 1 year will be 1,00,000*9% = Rs.9,000.
Hold on !!! Rs.9,000 is not your net profit…how can you forget Tax. So net profit as per your tax bracket will be as follows;
Taxation of FD’s:
Note: Interest from Bank FD’s is added to your income & taxed accordingly.
|No.||Profit Before Tax||Tax Bracket||Profit After Tax|
To know more about how to calculate tax read my Article: How To Calculate Tax
Instead of investing in Bank Fixed Deposit if you invest in a Debt Mutual Fund (funds investing in government securities & bonds with very less or no exposure to equity), you will get indexation benefit resulting in very less or at times no tax payment.
Say you deposited Rs.1,00,000 in Mutual Fund “Fixed Maturity 370 days Plan” on 28th March 2011.
About Fixed Maturity Plan (FMP’s):
– Debt Mutual Fund
– Maturity Period: 370 Days
– Rate of Interest: Similar to prevailing Interest rate of Bank FD’s maturing in one year.
So at 9% rate of Interest, your MF will mature on 2nd April 2012 & will fetch you approximately Rs.9,000.
Note: 9% rate is not fixed, so maturity amount is taken as approx. Though most of the times returns from FMP’s are in line with returns from Bank FD’s.
Taxation Of Mutual Funds:
Debt Mutual Funds are taxed @ 10.3% without Indexation & 20.6% with Indexation. In this case since MF is sold after 365 days, it will be termed as Long Term Capital Asset. To know more about Long Term Capital Asset & Indexation, read my article: Indexation.
|3.||Profit||Buying Price – Selling Price = 9,000|
|4.||Tax on Debt MF||10.3% without Indexation|
|5.||Tax Amount||9,000*10.3% = Rs.927|
|6.||Profit After Tax||9,000 – 927 = Rs.8073|
Note: No matter in which tax bracket you are, tax on long term capital gain from mutual fund will be taxed @ 10.3% (Without Indexation)
|4.||Indexed Purchase Price||1,00,000*(852/711) = 1,19,831|
|6.||Profit||Selling Price – Indexed Purchase Price = ( -10,831 )|
|7.||Tax On Debt Mutual Fund||20.6% with Indexation|
|8.||Tax Amount||Nil, as tax is calculated on profit & with Indexation profit comes to be zero.|
|9.||Profit After Tax||9,000|
Since in Case2. (With Indexation) we need not to pay tax, hence we will choose the Indexation method.
Conclusion: Generally retail investors do not know about Debt MF & they deposit their money in bank FDs & end up paying tax as per their tax slab. So it’s better to Invest in Debt Mutual Fund than Bank FDs.
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