Fixed Maturity Plans (FMPs) are not spoken about much now, but if you’re looking at getting reasonable tax free returns, consider this:
FMPs invest, typically, in debt that matures in the same term as the FMP. A 1 year FMP typically buys whatever matures in a year. It’s March today and the financial year 2011-12 will end on March 31. There are FMPs that are greater than 385 days – meaning they will effectively end in April 2013.
The tax code (even the DTC) says that if you buy something in one financial year and go past two financial years, you can use an indexation benefit to allow the impact of inflation before you pay tax on your returns. The formula is:
Gain = Sell value – Indexed Purchase value
= Sell value – Purchase Value* (CII for FY of sale)/(CII for FY of purchase)
The idea here is that you
a) buy now = so your CII for year of purchase is the one in FY 2011-12
b) sell in April 2013, so your CII for year of sale is FY 2013-14
(For more, read: How To Calculate Long Term Capital Gains Tax)
Effectively get both the inflation in 2012-13 and 2013-14 to index. Assuming 8% inflation each year, about 16% returns are totally tax free! Of course, you will make only about 10.5% or so, which means you actually can declare a “loss” of about 5% odd, which you can then adjust against other such long term capital gains (assuming that post indexation there are any gains in other non-equity funds/investments you sell).
There are many actual products that you can buy; FMPs are released with very short buy dates. A fund I’ve been told about – Reliance Fixed Horizon Fund XXI Series 18 – which can only be bought between 12th March and 14th March, and invests only in bank CDs. Don’t worry if you miss the date, they’ll be a new one soon. And most mutual funds are good, in this respect (HDFC, Reliance, Axis MF, etc.)
The 10% net of tax return is way better than a fixed deposit at a bank, where the interest is taxable. A 10% bank FD means a 7% net return for a person who is in the 30% bracket – there is no concept of indexation.
Downsides: you can’t exit earlier, you’re locked in for a year. If interest rates go up, you don’t get any advantage. There’s also the risk that yields can change – I’m just telling you the current market yields, these can go up and down on the date of purchase, which can change returns. They don’t typically change, but who knows. Finally, only choose funds that invest in bank CDs that are at the top of the pile – those are least likely to default. Do not choose those that buy Commercial Paper.
Disclosure: I might buy an FMP next week, if money gets really tight after the advance tax payment (it’s a risk, yields could even come down). But I’m finding the going really good on ultra short term funds (10% odd, still tax free for me) and might need the liquidity very soon, so my decision will change.
Also, I am a registered mutual fund advisor – largely for a friends and family network – so you should know that this info might be biased. (I don’t think so but I’ll let you decide). Finally, note that I’m not being paid directly by any of these funds for this post. They might buy into a third party ad service to advertise on this blog but I don’t have any control over that process.