Growth Option in Monthly Income Plan (MIP) and Systematic Withdrawal Plan (SWP)
Financial planning has two angles to it, one is the investment, and the other withdrawal either regular or one time. While the systematic investment plan (SIP
) helps you invest in mutual funds at regular intervals, systematic withdrawal plan (SWP) can help you redeem a fixed amount to meet daily expenses and churn the portfolio, when needed. This article explains how investors can derive a regular income stream and benefit from tax friendly option by picking the growth option in monthly income plans (MIPs), rather than depending on dividends.
What are MIPs?
MIPs known as Monthly Income Plans (Monthly Income is not assured and is subject to availability of distributable surplus) are debt-oriented hybrid mutual funds, with a marginal exposure to equity (up to 20%). Conservative investors, with a moderate risk profile will find these plans worthwhile, as they are relatively less volatile than pure equity funds, but slightly riskier than pure debt funds.
MIPs offer two options - growth and dividend (payout and re-investment). Those keen on a regular source of income can opt for monthly, quarterly, half-yearly or annual payouts as per frequency available under the Scheme
However, MIPs are not obliged to declare dividends every month, even as the name depicts a monthly income. Dividend pay-outs are purely dependent on the scheme’s distributable surplus , from time to time. Investors who are not looking at regular dividend income can pick the ‘growth’ option, where gains are reinvested into the scheme and the investor benefits from capital appreciation.
SWP – A controlled and tax friendly way of regular income
Between growth and dividend options offered by MIPs, those seeking regular cash flows should opt for growth. First of all, dividend pay-outs are based on distributable surplus available under the scheme and are at the discretion of the fund manager. Secondly, the date and amount of the dividend payment might not be in sync with the investor’s need. Thirdly, even though dividends declared by debt-oriented mutual funds are tax-free for investors, the fund house does deduct the dividend distribution tax (DDT). The DDT is 28.84% (including surcharge and cess). Thus, even if the fund house for instance declares a dividend of Rs 2, an investor would receive only Rs 1.42.
Investors can alternately avail of the SWP offered by MIP funds, under the growth option. The SWP enables investors to withdraw of a specified amount regularly, thus addressing two shortcomings of the dividend option viz., quantum and timing. Thirdly, SWPs are more tax-efficient than the dividend plans, which is also implied in the below case study.
SWP – An illustration:
Assume the investor has parked Rs 1,20,000 in a fund which is growing at 1% per month and wants to withdraw a fixed amount of Rs 1000. The above illustration is made to understand the benefit of SWP in the growth scheme of an MIP and should not be considered as an assurance of any returns. All recipient of this material are advise to make their own investigation, seek appropriate professional advise and read the Scheme Information Document carefully before taking any decision of investment. Investors can also use SWP calculator
tool, which calculates how much you would have gained if you had invested in Systematic Withdrawal Plan few years ago.
While withdrawals from debt-oriented mutual funds are taxed as per individual income tax slabs (the highest at 33%), investors need to pay taxes only on capital gains and not on the principal. In the above example, the investor needs to pay tax only on the gains component viz., Rs 745 vs Rs 12,000 withdrawn each year. Further, if the holding period exceeds three years, investors can benefit from a lower tax incidence, due to long term capital gains tax with indexation.
Types of SWP
Within the SWP, investors can choose to withdraw either at fixed intervals or else, link their redemption with capital appreciation. Under a fixed withdrawal, investors can specify a monthly withdrawal to pay utility bills, whereas a yearly withdrawal can be specified for other expenses such as philanthropy. Alternatively, investors can withdraw only when the investment has appreciated beyond a specified percentage. This keeps the capital intact and allows them to book profits.
Thus, investors can use SWPs to generate regular income to manage planned and unplanned expenses. SWP also instils discipline as the investor receives the amount in parts, rather than in whole so that expenditure is planned effectively. Investors are however advised to look at exit loads, tax aspects and perform due diligence before proceeding further.
Any information contained in this article is only for informational purpose and does not constitute advice or offer to sell/purchase units of the schemes of SBI Mutual Fund. Information and content herein has been provided by CRISIL Research, a Division of CRISIL Limited, and is to be read from an investment awareness and education perspective only. The views / content expressed herein do not constitute the opinions of SBI Mutual Fund or recommendation of any course of action to be followed by the reader. Investors should consult their financial advisers before taking any investment decision.
Mutual Fund investments are subject to market risks, read all scheme related document carefully.