MAXIMIZE MONTHLY INCOME

Do you want to know how to Maximize your Monthly Income than what is provided by your fixed deposits, post office investments  etc.? 

Very simple, invest in MIPs and read the below article completely to get a thorough insight as to how to maximize your monthly income.

MIPs stand for Monthly Income Plans offered by Mutual Funds. Many a time people have confusion between SIPs and MIPs.

SIPs are a way or method of investing in Mutual Funds.

MIPs are debt oriented hybrid products offered by Mutual Funds. 

SIP is a method and MIP is a product. 

So do not get confused between a SIP and a MIP.

Do you know ‘Asset Allocation’?  This means allocating your money amongst various assets like Land, House, Gold and Financial assets.

Financial assets are again classified into Debt and Equity.

Debt refers to products like Employees Provident Fund (EPF), Public Provident Fund (PPF), Postal Savings, Fixed Deposits, Senior Citizen Savings Scheme, Bonds, Debentures, Debt Funds offered by Mutual Funds etc.

Equity refers to Shares, equity schemes offered by Mutual Funds etc.

Mutual Funds offer a unique product called MIP (Monthly Income Plan) which normally invests around 75% to 80% of the assets in Debt like Government Securities, Commercial Papers, Certificate of Deposits, Credit agency rated bonds, NCD (Non Convertible Debentures), Floating rate notes, Money market etc. They have the mandate of investing upto the balance 20% to 25% in Equity. They may also have the option of staying 100% invested in pure debt, if the fund manager feels that it is not advisable to have equity exposure at a given point of time.

MIPs  aim at  enhancing the return over and above what one normally gets out of  Fixed Deposits and Postal Products.

I want to provide you an example of two of our favourite MIPs among our recommendations of few MIPs which are again amongst the entire universe of MIPs offered by all Mutual Funds inIndia.

Two of the MIPs we suggest as part of one’s core MIP holding, have provided annualized return of around 12% over the last 5 years period and have also provided an annualized return of around 11% to 12% since inception (nearing 7 years).

Compare the above returns with your other small savings fixed income products. You stand to gain more in good MIPs. Even a small increase can make a lot of difference to investors in Debt based products.

Disclaimer: Mutual Fund investments are subject to market risks. Past Performance may or may not be repeated in future. Please read all the scheme related documents carefully before investing. MIPs are not guaranteed returns products like Fixed Deposits, Postal Savings etc. and are riskier than the same. The above data is as on June 30th’11.

The minimum holding period we suggest for a MIP is 5 years, to get a significant return over and above a Fixed Income product.

Please do not forget the above disclaimer.

MIPs offer tremendous tax advantage.

There are mainly two options to choose from, dividend option and growth option.

Most of the advisors in the market suggest dividend option for people who need regular income without realising how they are minimizing the returns and jeopardizing the cash flow of an investor by suggesting this option.

Let me tell you why.

Dividends from MIPs are tax free in the hands of investors. But they do not realise that the mutual fund companies pays 13.84% as ‘Dividend Distribution Tax’ on the dividends paid, out of the scheme (Investors’ money) effectively reducing the returns of investors. Not only that the percentage of dividend declared is not consistent, and there are months when dividend payments are skipped. People who are dependent on a fixed and regular cash flow suffer a lot because of this.

Instead if they invest in growth option and start withdrawing a fixed sum through SWP (Systematic Withdrawal Plan) from the 13^th month onwards, they have two advantages. Being long term capital gains, irrespective of the tax bracket an investor belong to, the tax rate is only a flat 10.3% (without indexation).  This means they pay only 10.3% on the gains made viz-a-viz 13.84% tax on the entire money paid out as dividend.

Since the amount and date of withdrawal is fixed by an investor, he has a fixed, regular and predictable cash flow.

The withdrawal should start only from 13^th month for the returns to be classified under ‘Long term capital gains’. If the amount is withdrawn during the first one year, it attracts an exit load of 1%. Not only that the returns are taxed as ‘Short term capital gains’, the tax rate being the tax bracket under which an investor falls into. If the investor is in the highest tax bracket, he has to pay tax at the rate of 30.9%.

Someone may ask, what I’ll do for one year without an income.

Very simple, what you require for the first year, keep it in your Savings Bank Account, earning 3.5% p.a. You invest only the balance amount for long term and can start the withdrawal from 13^th month onwards.

The fixed income you would be getting out of your corpus, would be perpetual (subject to capital not getting eroded, for which chances are less, if you opt for a right percentage of withdrawal in discussion with your Personal Financial Advisor) and you can keep increasing your income by keep increasing the corpus.

How to increase the corpus, if you’ve no chances of getting money in future through any other means?

Simple Mr.Investor. We always advice to save atleast  20% of one’s income and keep reinvesting it in equity funds through SIPs (Systematic Investment Plan). This is to keep pace with inflation. If you don’t do this, the fixed income which you receive now, which is sufficient for your current cost of living, would cease to be sufficient in the years down the line.

As your SIP corpus keeps growing, once in 5 years or so, you can move the accumulated corpus to MIP. This would increase your MIP corpus, there by increasing your monthly income. Again you’ve to ensure that, atleast 20% of that money is saved through SIPs.

You’ve to keep doing this once in every 5 years so that your monthly income keeps growing and you will be able to manage the increasing cost of living.

Living long can be as risky as dying young, so says a great philosopher, who else, none other than Mr.Muthu!

Just ensure that MIPs form a core part of your financial assets.

Addendum: Written on 13^th July 2014 after the presentation of budget for FY14-15

So far for the first year, MIPs are taxed at the tax slab you belong to and from 2’nd year onwards at a flat rate of 10%. Accruals are tax free and the taxation arises only at the time of withdrawal. There is no TDS (Tax Deducted at Source) also.

What has changed?

From now on, MIPs would be taxed at the tax slab you belong to for the first 3 years and from 4th year onwards the taxation rate would be 20% with indexation. Indexation means adjusting for inflation. So the actual tax rate would be significantly lesser than 20%.

To illustrate:

Let us assume you’ve invested Rs.1 lakh in a MIP scheme in March 2011. Let us also assume you got an annualized return of 10% and is withdrawing the same in April 2014.

Cost of inflation index for 2010-11 is 711
Cost of inflation index for 2014-15 is 1024

So Rs.1 lakh adjusted for inflation is 100,000/ 711 * 1024= Rs.1,44,022/-

At 10% returns, your MIP would have become Rs.1,33,100/-

Since the MIP value is lesser than inflation adjusted capital, there is zero tax liability for you.

My guess is that if inflation is high, you may have negligible or even no tax and if inflation is low or moderate, you may have significantly lesser tax (than the rate of 20%).

What has not changed?

The accruals continue to be tax free (i.e.) taxation is applicable only when you actually withdraw the gains. As long as you let it grow, there is no taxation. As you are aware, FDs are taxed on accruals every year.

There would be no TDS (Tax Deducted at Source). In MIPs, you’ve to declare the gains and pay taxes unlike FDs where the tax would be deducted at source and you would be paid only the balance.

What you should do now?

The minimum holding period we suggest for MIPs is 5 years. There is no change to that. We ask you to start SWP (Systematic Withdrawal Plan) from 13th month onwards so that there would not be any exit load. Even now you can continue to do the same. However from 13th month to 36th month, the tax rate would be the tax slab you belong to. From 37th month onwards, it would be 20% with indexation (which as explained above would be lesser than 20%).

I also want to highlight one more point. The SWPs of MIPs, each withdrawal, has a principal and an interest (gain) component. The tax would be applicable only on the gain part and not on the principal part. So you don’t pay tax on the entire withdrawals but only on the gain part.

So despite the changes in taxation in the recent budget, MIPs continue to be attractive.

On top of all these, MIPs are capable of giving returns superior to fixed deposits and many of you know this from your past investment experience itself. Though past returns do not guarantee future, it is a pointer for the potential and possibility.

Reference: 

http://wisewealthadvisors.com/maximize-monthly-income/?blogsub=confirming#blog_subscription-3