Fixed Deposits Vs Fixed Maturity Plans’ – What to Choose?

Banks have been luring investors by offering attractive deposit rates, but FMPs, with tax-adjusted returns, still score higher. Fixed Maturity Plans, FMPs, are as attractive as Bank FDs in terms of interest rates. Further, on account of lower taxes on MFs, post tax returns from FMPs is far better. Currently 90 day Bank FD offers 5.50-5.75% whereas FMPs of 90 days are offering 6.85-7.10%. FMPs combine tax efficiency of MFs with the safety of fixed deposit. FMPs generate significantly better post tax returns.
Taxation Aspect The interest earned on Bank FDs has to be added to the income of that year and tax is to be paid as per your tax slab. But in a FMP for a tenure of lesser than a year if the investor chooses the dividend option then he can just come out by paying a 14.03% or 22.44% dividend distribution tax, depending upon the individual or corporate investment category respectively, which is deducted by the MFs at the time of distributing the dividend. The attraction increases when the term selected by the investor is over 365 days. Let's consider a bank FD offering 8.00% and an FMP offering 8.00%. In a bank FD the investor have to pay 30% tax (if you are in the highest tax bracket). So his post tax return is 8.00% minus 30% tax on it, which leaves you with a paltry 5.60% post tax returns.
Whereas, in FMPs he needs to pay just 10% concessional Long Term Capital Gain Tax without indexation or 20% with indexation for investments of over a year. So his post tax return is 8.00% minus 10% tax on it, which leaves him with a 7.20% post tax returns. In institutional plans, corporates earn additional 0.25% – 0.40% pa returns. Though banks are offering 8.00% for 366-390 day deposits, the rate of interest is lower on higher terms. Banks are offering 7.50% (8.00% for Senior Citizens) for terms over 2 years and attract the usual 30% tax (for highest tax bracket individuals) whereas FMPs offer 8-8.10% returns.
How does a FMP work? FMPs produce predictable returns over the desired timeframe since the maturity of the portfolio matches the tenure of fund schemes. Unlike other schemes that suffer from volatility and, hence, risk of erosion in asset value, an FMP – structured as closed-end funds – carries no interest rate risk. Whether yields rise or fall, the asset value of these schemes is protected as deposits / bonds are held to maturity. FMPs, being close-ended, are available for investment only during their initial offering. They are available at the face value of Rs 10 per unit. These schemes don't levy any entry load. Minimum investment normally is just Rs 5000/-.
Other AlternativesIn such scenario, where you may need your funds back at short notice, Liquid funds should be preferred over bank FDs & FMPs. Liquid funds have no specific term and can be withdrawn anytime. In Bank FDs. if you make 15 days FD and renew every 15 days, you will lose on the interest rate. If you make a 6-month bank FD and if you have to prematurely withdraw it, you pay 0.50% penalty on the applicable interest rate for that period of deposit. In FMPs, if you have to prematurely withdraw it, you pay an exit load.
Banks are offering 8.00% (compounded yearly) for 5 years lock-in FDs under section 80C. They can't be withdrawn prematurely. No loans are available on it. NSC seems to be a comparable option with 8.00% for 6 years (compounded half-yearly – yield 8.16%). Loans are available against NSCs. Also the accrued interest is eligible for 80C deduction.

Tax plan funds catch retail investors' fancy

Tax planning mutual funds have come into their own as a compelling cocktail of savings and returns, surpassing larger rivals such as equity funds in asset growth rates over the past year and a half, fund watchers said. From a mere 6.84 billion rupees in assets managed by 20 funds in March 2005, equity linked savings schemes spurted to 53.54 billion rupees managed by 26 funds at the end of August 2006, data from mutual fund tracking firm Value Research showed.In 2006 alone, ELSS assets have so far risen nearly 70 percent, more than double the rate of diversified equity funds, which of course have a much larger base."These (ELSS) are evergreen funds," Ajay Bagga, chief investment officer at Lotus India Asset Management Co. Pvt. Ltd. which plans to launch a scheme in this category, told Reuters."Every year investors have to save tax and if funds generate good return and give steady dividends, they would keep getting money from them," he said.The major reason for the category's growing popularity among retail investors is a decision by the Indian government, in early 2005, to raise the investment limit in such funds eligible for tax breaks from 10,000 rupees to 100,000 rupees.In an economy expected to grow above 7 percent, where rising middle-class incomes translate to higher tax outflow, this concession meant easy savings through a high-returns investment option.Fund houses' collections gave further evidence by reaching 27.81 billion rupees in the first eight months of the current financial year, compared with 4.29 billion rupees in the same period last year.Tax-planning funds on an average have given about 13 percent returns this calendar year -- not far behind a 17 percent gain by diversified equity funds -- in addition to saving tax outgo."Performances have actually brought in money," N. Sethuram Iyer, chief investment officer of SBI Funds Management (Pvt.) Ltd. said.In the three-year period ending September 14, an average ELSS has gained 45.97 percent annually as compared to 46.31 percent returns in diversified equity fund, as per Value Research data.Magnum Taxgain gave 81.63 percent annualised return, compared with 75.83 percent gained by the top diversified equity fund during the period.The three-year lock-in stipulated by the authorities also keep money within a taxplan fund allowing it more freedom in investment, fund managers said."Turnover tends to be lower in these funds because the fund manager can let his ideas ride instead of facing near term redemption," Bagga said.Since March 2005, six new funds have been launched, while Lotus India and HSBC Asset Management (India) Pvt. Ltd. are planning to roll out theirs."Now investors are realising the value of close-ended three year product," Vikrant Gugnani, president of Reliance Capital Asset Management Ltd. told Reuters."We are very bullish on this category," Gugnani, whose 11.41-billion-rupee Reliance Tax Saver (ELSS) Fund is the largest tax-planning equity fund, added.

ULIP shines over MFs in long term

For a long time, ULIP (unit-linked insurance plan) had become the financial market's favourite four-letter word. There was good reason.

This insurance-investment combination product was being grossly misrepresented. Agents and sales reps were earning unbelievable commissions and, unfortunately, the bad eggs took advantage of this. Despite all this, ULIP can be a great instrument to invest in, if you are willing to stick to it for a long period of time — in the range of 10 to 20 years. If you have a short span of time at your disposal, it is better to invest in mutual funds and buy term plans to take care of your insurance coverage.

Main differences between ULIP and ordinary mutual funds is variation in expenses — administrative charges, mortality charges and, of course, fund management fees. We are going to compare the two products to suggest that, over a longish period, ULIP's expenses work out to be lower than that of an equity mutual fund, and so you end up getting more of your money to work for you.

Since insurance companies charge enormous selling expenses in the range of 15% to 50% of the first year's premium, short-term investors stand to lose. But, if one were to analyse the benefits of ULIPs over mutual funds, all else being equal, there may be reason to look at ULIPs, purely because of the lower expense ratio: The asset management charge (AMC) of insurance companies is 1.5%, whereas in the case of mutual funds it is around 2.5%. Therefore, in the longer term, when the funds of individual investors under management become large, the difference of 1% matters a lot. It offsets the higher charges taken by insurance companies during the earlier period of the fund. Take for example an insurance company and a mutual fund, giving the same return of 10% per annum. The insurance company charges 40% of the first year's premium as selling expenses and 5% of premium every year as administrative charges. A person buys a unit-linked policy for 20 years, with a life coverage of Rs 20 lakh, and pays a premium of Rs 1 lakh per annum. In first year, Rs 40,000 will be deducted from his premium as commission, and Rs 5,000 as administrative charge. If the person's age is 30, the mortality charge of Rs 2,763 will also be deducted.
Furthermore, 1.5% asset management charge will also be deducted from this.
Therefore, in the first year, the investor will get units worth Rs 51,453 only. In the next year, his charges will be limited to 5% of the second year premium of Rs 1 lakh, plus mortality charges of Rs 2,654. Therefore, the net addition to the fund will be Rs 92,346 from the premium. If, in the first year, the fund gave a return of 10%, the net investment of Rs 51,453 in the first year will become Rs 56,598. If the fund continues to earn a return of 10%, the person will get Rs 45,59,846 after maturity. In case of MF, however, there is no selling charge, but there is an entry load of 2.5% of the premium every year. Besides this, there will be asset management charge of 2.5% of the corpus. Suppose you buy a term insurance which gives the same coverage as the ULIP. If you adjust for everything, the maturity amount after 20 years will be Rs 42,82,347 assuming a return of 10% per annum. So, maturity amount given by the MF is smaller than that from a similar unit-linked plan. This is mainly because of the 2.5% charge in the case of mutual fund as against 1.5% in ULIP. Because of 1% difference, the MF company charges much more than the insurance company. Towards end of the fund's life when corpus become large, the difference can be huge. The mutual fund company would end up charging Rs 82,198 in the 17th year and Rs 1,09,803 in the 20th year. As against this, the insurance company would charge Rs 50,614 in the 17th year and Rs 69,439 in the 20th year. In short term, return from MFs is better. If an investor goes for only 10 years instead of 20, his maturity amount in ULIP will be Rs 14,03,526 as against Rs 14,32,703 in MF. For 15 years, maturity amount of Rs 1 lakh premium will be Rs 26,76,504 in the case of ULIP and Rs 26,24,757 in mutual fund.