Monthly Income Plans for your post-retirement planning

Published On: 23-May-2022

Retirement planning is one of the ignored facets of financial planning since the millennial population does not believe in saving for the future but instead lives in the present. In contrast, it becomes crucial to have a healthy financial corpus to take care of the life post-retirement in the absence of any formal social security scheme in India. The post-retirement life is often considered the second innings when one can fulfil their pending aspirations.

With a wide range of mutual fund schemes available for investors, mutual funds can be a preferred investment vehicle to achieve financial goals over time. During the wealth creation time, one can have a larger allocation towards equity funds. This is because one enjoys the liberty of time available with them, and short-term volatility gets moderated over the long term. However, as one approaches the retirement age, one’s risk-bearing ability decreases over time, and the safety of invested amount is then prioritized over generating higher returns. As such, Monthly Income Plans (MIPs) can come to the rescue of such investors. MIPs fall under the conservative hybrid fund category investing predominantly in debt securities and allocating the remaining amount towards equity. As per SEBI Guidelines, conservative hybrid funds can invest between 75-90% of their total assets in debt securities while investing between 10-25% in equity securities. As such, the predominant investment towards debt provides stability to the fund portfolio and reasonable returns, while the equity allocation equips the investors with potential upside to the returns.

Monthly Income Plans do not guarantee Monthly Incomes

While the name may suggest that such funds provide guaranteed monthly income to the investors, it is not a valid analogy. As per SEBI Guidelines, mutual funds can distribute dividends to the investors under Income Distribution cum Capital Withdrawal plans only out of realized profits. There is no certainty of cash flows under Income Distribution cum Capital Withdrawal plans. Considering the recurring need for regular cash flows, such certainty becomes crucial and accordingly, one may register a Systematic Withdrawal Plan for ensuring regular cash flows.

Using Systematic Withdrawal Plans for Effective Retirement Planning

Mutual funds offer the Systematic Withdrawal Plan (SWP) option to allow the investors to redeem their mutual fund investments periodically. One can enjoy the benefits of wealth accumulated in the past through periodical redemptions. While Systematic Investment Plan (SIP) as an investment concept is quite popular amongst retail investors, SWP does precisely the opposite. SIP allows investors to channel their savings into mutual funds; SWP allows them to transfer their wealth from mutual fund units directly into the bank.

With SWP in Monthly Income Plans, investors enjoy the flexibility to specify a fixed amount that they wish to withdraw every month from their investments. Such an amount can be fixed considering the monthly requirements of the investor, including regular expenses.

Taxation of Monthly Income Plans

As per the Income Tax laws, an equity-oriented fund must invest at least 65% of its assets in equity securities and equity-related securities. Since MIPs predominantly invest in debt securities, they are classified as non-equity oriented funds. The capital gains are taxed at the redemption of mutual fund units. Further, one must note that SWP is not an investment product but only automates the periodic redemption of mutual fund investments. As such, it does not matter if the investor has placed a manual redemption request or redemption has been processed through SWP. The gains from such funds with a holding period of 36 months or more are classified as Long Term Capital Gains (LTCG) and taxed at 20% (plus applicable cess and surcharge) post the indexation benefit. Indexation helps the investors adjust the investment cost for the inflation prevailing over the investment period, leading to only inflation-adjusted returns taxed at 20%. Gains from such funds with holding period of less than 36 months are classified as Short Term Capital Gains (STCG) and taxed at the tax rates applicable to the investor.

Note: The tax provisions mentioned in the article are for illustrative purposes only and are updated as per the Union Budget 2022 presented in the Parliament in February 2022. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the investment date.