Mutual funds that retirees seeking regular income should opt for( 13:00, 24-Aug-16)
Retirees who invest in fixed deposits for regular income in retirement don't realise that their money is losing value due to inflation. Even though their monthly requirement will gradually go up due to inflation, their deposits will continue to give out a fixed amount. The best alternative are monthly income plans (MIPs) from mutual funds. These funds follow a conservative investment strategy, allocating only 10-20% of their corpus to equities and putting the rest 80-90% in safer bonds and other .. The good thing about MIPs is the relative safety they offer. "These funds will give investors good returns if stock markets do well but they will also protect the downside because of the limited exposure to equities," says Vidya Bala, head of research, FundsIndia.com.
MIPs are also more tax efficient than fixed deposits. Interest from fixed deposits is fully taxable. For a person in the 30% tax bracket, the post-tax returns from a fixed deposit that offers 8% is actually 5.6%. Worse, this income is taxed every year even though he may get it only after the deposit matures. Also, if it exceeds a certain limit, it attracts TDS, so there is no escape. Retired engineer Kalyan Ghosh was advised by friends to split his fixed deposits across different banks. That might help him escape TDS but the income will still be taxable
On the other hand, the gains from MIP funds are taxed only when the investor redeems the investment. Even then, only the gains are taxed and that too at a lower rate. Investing in MIPs can help retirees like Ghosh and Mangal Dutt Sharma bring down their tax liability.
Indexation reduces tax on gains
The gains from MIP funds are taxed only when the investor redeems the investment. If the holding period is more than three years, they will be treated as long-term capital gains and taxed at 20% after indexation. Indexation takes into account the inflation during the holding period and accordingly adjusts the purchase price of the asset. During times of high inflation, indexation can reduce your tax to almost nil. The best part is that the tax is deferred indefinitely till the investor withdraws the investment. Even then, only the gains are taxed at 20% after indexation.
Is monthly income assured?
Though these are called "monthly income plans", there is no assurance of monthly income. In fact, the dividend option of these funds is a very tax inefficient way to get a monthly income. Though the dividend received is tax-free, it comes to you after a heavy 30% dividend distribution tax. It is best to go for the growth option of the MIP fund and redeem units as and when you need the money. You can also start a systematic withdrawal plan (SWP) undEr which a fixed sum is redeemed every month and put into your bank account. Ideally, one should start redemptions after three years of investing for greater tax efficiency.
MIPs can be good source schemes for systematic transfer plans (STP) into equity funds. In an STP, a fixed sum flows out of the scheme to another scheme (usually an equity fund) on a predetermined day of the month or quarter.
Be wary of the charges though. MIPs have high charges (some charge up to 2.5%), which can be a drag on the overall returns.