Why it is wise to choose SWP over dividend option in MIPs
For people seeking periodic payments from their investments, Monthly Income Schemes and Monthly Income Plan Mutual Funds provide a good option. Monthly Income Schemes provide a periodic return on the investment based on the prevailing interest rate. Monthly Income Plans are hybrid mutual funds which invest majority of their funds in short or medium term bonds and money markets. A small portion of such funds is also invested in equity products.
With Government of India and Reserve Bank of India keen on driving the economic growth cycle of India, the interest rates are expected to reduce over this financial year. The lower interest rates would result in higher returns from the previously issued bonds. This increase the NAV of debt oriented mutual funds which invest in bonds. When this happens it would help the Monthly Income Plans (MIP) investors to gain good returns compared to Monthly Income Schemes.
Investors can choose between Monthly Income Plans with a Dividend payout Option or Growth Option. Monthly Income Plans with dividend payout option provide a regular stream of income in the form of dividend payments. The dividends are paid from the profits made by the mutual fund. The frequency of this dividend payout is opted by the investor at the time of investment. They can opt for a monthly, quarterly, half-yearly or yearly payouts.
Monthly Income Plan with Growth Option reinvests the profits in the existing or new holdings of the scheme. Since no dividend payments are made, NAV of growth option is generally more than the dividend option. Investors can opt for a Systematic Withdrawal Plan on their Monthly Income Plans with growth option to withdraw periodic payments.
Features of Monthly Income Plan with dividend payout option
No guarantee of monthly dividend income - As per the regulations, dividend can only be paid from the profit made but not from the invested capital. For example, if the NAV on the date of investment is INR 11.45 and if it is INR 12.00 at the time of payout, dividends should be paid only from INR 0.55 (12.00-11.45). If the NAV of the fund is less than the NAV on investment date, no dividends are paid. This feature implies that there is no guarantee of periodic payments. The periodic payments are solely based on the performance of the fund. If the performance of the fund is bad, no dividend payments are made. This defies the purpose of MIP, which is to provide income at regular intervals.
Dividend Distribution Tax is deducted by the company before paying to investors - Though the dividend received on the MIP is tax – free in the hands of investor, all non – equity investments attract a dividend distribution tax of 25%. For any dividend being declared, the company should pay this tax and the remaining amount is distributed to the investors.
Advantages of MIP with growth option and Systematic Withdrawal Plan
Assured regular monthly income - In a Systematic Withdrawal Plan, investors can decide on the amount of monthly payments they want to receive. As opposed to dividend option, the payments are made from the accumulated amount i.e. the invested capital and capital appreciation gained. This ensures that the regular payments are made. In this option, the performance fund only affects the net value of the fund. It does not impact the periodic payments which investors seek from such investments.
Tax efficient: Choosing a SWP on MIP with growth option is a tax efficient way of enjoying the benefits of the investment. Investors opting for SWP are subjected to paying short term capital gains or long term capital gains depending on the time frame they opt. One of the efficient strategies is to start SWP after one year from the investment date. This ensures that the withdrawals are only subjected to long term capital gains. Long term capital gains on debt funds are taxed at flat 10% or 20% with indexation benefit. The total tax liability will be less than the dividend distribution tax charged in the case of dividend option. This also increases the net return on the investment.
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