Generating a substantial regular monthly income to support or substitute salary or other earned income is a dream for everyone and is a necessity for retired people.
Generating a substantial regular monthly income to support or substitute salary or other earned income is a dream for everyone and is a necessity for retired people. Such a dream may only be fulfilled once you have substantial corpus for lump sum investment to generate a meaningful return.
There are many investment options available that generate regular monthly income to replace your source of earning, e.g. Monthly Income Plans (MIP) of banks/Post Office, monthly dividend payout options of mutual fund (MF) schemes, Systematic Withdrawal Plan (SWP) from MF schemes, annuity plans offered by life insurance companies, Pradhan Mantri Vaya Vandana Yojana, etc.
Now, let’s discuss the advantages and disadvantages of MIP, Dividend Payout and SWP.
Monthly Income Plan (MIP)
MIPs are like Fixed Deposits (FDs) or Time Deposits, where an investor has to invest in lump sum. However, in FD, the minimum duration to get interest payout is on a quarterly basis, whereas in case of MIP, the interest payout is on a monthly basis. So, MIPs give a feeling of regular income, like that of monthly salary, to which salaried people are used to.
Like FD, MIPs also have a specific investment period, in which the rate of interest remains fixed. So, the return is guaranteed, but MIPs carry reinvestment risk, as the rate may get changed when the principal is reinvested at the end of the term of the existing MIP. As MIPs are not market linked, the principal invested doesn’t fluctuate and in case of Post Office MIP, the principal invested also enjoys sovereign guarantee.
However, in case of Post Office MIP, the maximum investment limit is Rs 9 lakh jointly and the current rate of interest is 7.6 per cent per annum, payable monthly. So, a couple may get maximum monthly interest of Rs 5,700 by investing Rs 9 lakh jointly in Post Office MIP.
The interest received is also taxable in the hands of the investors, so may not be lucrative for people in higher tax bracket.
Like companies, MF schemes also pay dividend to unit-holders out of the profit/growth generated by the schemes. Few schemes make dividend payout on a monthly basis, while for most of the schemes the payouts are irregular.
Although some prominent equity schemes provide dividend at a higher rate of about 10 per cent, with monthly payout, but the principal invested face market volatility. So, in case of steep fall in stock markets, few payouts may be skipped to protect the capital. Comparatively, the dividend payout may be lower for debt funds, but such funds are less volatile than equity funds.
Dividend income from Indian companies are tax-free in the hands of investors up to Rs 10 lakh in a financial year, but high dividend distribution tax (DDT) rate of 10 per cent on equity MFs and that of 25 per cent on debt MFs take the lustre out.
Systematic Withdrawal Plan (SWP)
While a Systematic Investment Plan (SIP) is used to invest in a regular basis to accumulate wealth, Systematic Withdrawal Plan (SWP) is used to take out money from a MF folio periodically in a systematic way. Like SIP, an instruction for SWP is given to an AMC to transfer money from the folio of an investor to his/her bank account in a regular frequency, say on a monthly basis.
Withdrawals through SWP may be done from both equity and debt funds and at the time of withdrawal, gain or loss will be calculated for tax purposes. Withdrawals within 1 year from equity funds and within 3 years from debt funds from the date of respective investment dates would be treated as short-term capital gain (STCG) and withdrawals beyond the specific time periods from the date of investments would be treated as long-term capital gain (LTCG).
The tax rate on STCGs on equity funds are taxed at 15 per cent, while STCGs on debt funds are added to the annual income of the investors. Investors have the option to offset the STCGs against short-term capital losses.
The LTCG up to Rs 1 lakh in a financial year on equity funds are tax free, while that of debt funds are taxed at 20 per cent after indexation. So, on the taxation point of view, SWP scores over the other two options to get a regular income.
Although, there are more tax benefits on equity funds, but there are chances that the investors may lose part of capital invested in case of SWP at the time of steep market corrections. So, it is advised to exercise SWP on debt funds due to relatively stable nature of capital invested.