When investors think of ways to generate monthly income they think of rental income from property, pension, annuities, fixed deposits and post office schemes. Few think of mutual funds as a way to generate monthly income. This is due to the misconception that mutual funds are mainly for capital appreciation and investment in equities. There are plenty of options out there for investors searching for ways to generate monthly income. One such type of investment is a Monthly Income Plan (MIP).
Monthly income plan
An MIP is a mutual fund scheme that primarily invests in debt instruments (75-85%) with a smaller portion of equity (15-25%). MIPs are suitable for investors who want their portfolio to give steady returns that are better than a fixed deposit while accepting slight fluctuation. The average return for the past year on an MIP has been around 11%, whereas fixed deposits typically gave returns of below 7%.
An MIP offers both growth and dividend options. Dividend option allows regular income in the form of periodic (monthly, quarterly, half-yearly) dividend payouts. These dividend payouts are tax free in the hands of the investor. However, dividend payouts are subject to dividend distribution tax, this tax is paid out of the dividend distributed to the investors. The effective tax rate on the dividend distributed to investors amounts to 28.33%. Another point to note is that the frequency and amount of the payoff is decided by the fund house.
A better way to achieve regular income is by using an MIP growth scheme with a Systematic Withdrawal Plan (SWP). An SWP enables an investor to make an automated withdrawal of a specific amount or number of units from his funds at specified intervals (monthly or quarterly). The investor can modify this amount and payout interval at any time. This flexibility is beneficial for an investor looking to set up a monthly income stream.
The key benefit is that withdrawals under an SWP are subject to capital gains tax. A short-term capital gain (holding period less than one year) is based on the investor’s income tax slab. However, long-term capital gains tax rate for MIP is 10% without indexation and 20% with indexation. This is much lower than the 28.33% paid, when using the dividend option.
Vaibhav Agrawal is head of research, Angel Broking