Investors tend to choose traditional options when it comes to investing their own money for a regular monthly income. We have seen people opting for real estate assets in case they want monthly income from their investments as rent will be regular. The average rental yield in India for residential real estate assets is 3%, and this is less than FD interest rate which currently is close to 7%. However, financial assets like mutual funds offer much better yields and post tax returns in the long run. We explain how you can withdraw a sum every month from mutual fund investments.
Generating regular income from your investments in financial assets
There are two efficient ways of generating regular income from your investments. You can either invest in schemes that are offering regular dividend or you can opt for regular withdrawals through Systematic Withdrawal Plan (SWP).
Dividends paid by mutual fund schemes are different from dividend paid by companies. Companies pay dividends through their profits. Funds work on the principle of net asset value (NAV) which reflects the valuation of their holdings or the price of asset(s) a fund may be tracking. Appreciation in this NAV value is transferred to investors in the form of dividend. For eg, if base NAV of a scheme is 100 and over certain period it becomes 103, then Rs 3 are transferred to investors in the form of dividend and NAV value reduces to 100.
Systematic Withdrawal Plan (SWP) is a facility offered by mutual funds which offers investors ease to withdraw a pre-decided amount of payout at a pre-determined intervals, like monthly, quarterly, half-yearly or annually.
With the SWP, you can customise the receivables as per your requirement. You can choose to withdraw certain percentage of the invested corpus or fixed amount or just the capital gains. This facility enables you to remain invested in the scheme at the same time allows to access your money.
What should you choose: Dividend or SWP?
Dividend option reduces the exposure to risk as the scheme books profits at regular intervals and transfers them to you. However it is important to note that dividend distribution is subject to availability of surplus. In case the scheme has not made any gains owing to market volatility the fund house may choose to not pay dividend even as the dividend payout date is pre-decided. This could potentially disturb your financial planning. Yet, it will protect your capital. Of course, if the markets are volatile it will reflect in scheme performance but in case the markets are flat and NAV hovers around the base NAV, dividends will not be declared and your initial invested money is protected.
In case of SWP you will keep receiving the regular income as instructed by you. This will ensure your requirements are attended to and your financial plan is on track. However your initial invested corpus may reduce if your withdrawals are higher than the returns generated by underlying scheme or in case of underperformance.
Dividends are tax-free in the hands of investors. Dividends in debt mutual funds attract Dividend Distribution Tax (DDT) of 29.12%, and in equity mutual funds there is a DDT of 11.65%, which is paid by the mutual fund. Dividends reinvested back in the scheme are also taxable. While SWP taxation will depend upon the asset class of the underlying scheme.
In case of debt schemes Short Term Capital Gains (STCG) tax will be applicable for investment period of less than three years, it will be as per investor’s individual income tax slab. For three years and above, Long Term Capital Gains (LTCG) tax of 20% with indexation benefits will be applicable.
In case of equity schemes, STCG of 15% is applicable for holding period of less than one year. In excess of one year, LTCG tax of 10% will be levied; however capital gains below Rs 1 lakh are tax free in the hands of investors. In addition, it is also important to check exit load of the schemes as withdrawals through SWP route are not exit-load free. However most of the mutual fund schemes are offering exit load free withdrawals for 15% of the corpus annually.
Let’s see for a similar cash outflow, which option delivers better returns to investors.
Mr. Bakshi has retired as a senior manager from a private sector bank. He doesn’t have pension, however, he has saved Rs 1 crore and want to invest them in such a way that his current lifestyle is maintained. He decided he would want to withdraw Rs 75,000 per month. To decide which route to use for attaining his goals, he did a retrospective analysis of SWP and dividends. Even though capital gains and dividends from equity were tax free before March this year, he considered current tax rates for his analysis. He wants to have exposure to diversified equity fund thus he considered a top performing (in last 10 years) multi-cap scheme – SBI Focused Equity Fund. Here is what the analysis tell us:
Post-tax return comparison for SWP & dividend in SBI Focused Equity Fund
|SWP / Dividend per month||75,000||75,000|
|Total Cash Withdrawn over 10 years||9,075,000||9,075,000|
|Tax Paid as per current Tax rates||6,66,555||1,048,320|
|Tax as % of amount withdrawn||7.34%||11.55%|
|Total cash withdrawn post taxes||8,408,445||8,026,680|
The scheme grew at ~23.78 CAGR since October 2008 to 30th November 2018. After withdrawing Rs 75,000 per month for 10 years through SWP route, the fund corpus still stands at whopping Rs 6.6 crore. (For calculating Lump Sum returns, use our Lump Sum calculator). The effective tax on SWP is also lesser than that of dividends.
RupeeIQ take: Switching to financial assets for regular income purposes have worked going by the above example. Also SWP is a superior choice compared to dividend when it comes to taxation. The choice of which route to adopt depends on investor’s requirements. In case they are wary of fund performance, they should go for dividends to book profits regularly. In case, they want uninterrupted regular cash flow, SWP stands to be a better option, along with a potential of wealth creation over long term. Even though the example we have shown is based on the actual returns of SBI Focused Fund for the last 10 years, the past performance is not an indicator of future performance.
Disclaimer: Please note that investors are requested to consult their financial, tax and other advisors before taking any investment decision.