Monthly Income Plans – Another way to earn an extra buck
Raghu: “You know Nitin, I just heard about a new investment instrument. They are called Monthly Income Plans. Have you ever heard of them?”
Nitin: “No I haven’t. But they sound interesting. Could you elaborate on it?”
Raghu: “Well, Monthly Income Plans are give returns to investors on a regular period.”
Nitin: “Well there must be more to it, right? A lock-in period maybe?”
Raghu: “Wait, I’ll explain everything to you in detail.”
What are Monthly Income Plans?
An MIP or, a Monthly Income Plan, is a scheme of a mutual fund which invests mostly in less risky debt instruments like government bonds, debentures, treasury bills, commercial paper and gilt funds. The remainder is invested in equity or cash. MIPs may have a minimum lock in period of usually three years after which investors can choose to stay in or exit the fund. The investor receives income in the form of dividend which can be received or reinvested in the scheme. The two options are elaborated below:
MIP with dividend payout option: Dividends are declared in the MIP scheme of the fund. One can opt to receive the dividend either on monthly, quarterly, half-yearly or yearly basis or when the fund declares the dividend. This dividend is tax-free for the investor though the company has to pay distribution tax. Hence, the returns automatically reduce. This option would be suitable for investors with low risk appetite and who would prefer receiving income regularly.
MIP with growth option: Under this option, the dividend is not paid out at regular intervals but is reinvested in the scheme/fund. So, when the fund matures or the lock in period (if any) ends, the investor gets a higher return as opposed to someone who opts for the dividend payout. This option is suitable for those who have a higher risk appetite and holding power.
Features of Monthly Income Plans
Dividends can be declared only from the profits and not from capital invested.
There is no guarantee of regular income/dividend as returns depend on stock market performance, interest rates, etc. It is declared at the discretion of the fund.
MIPs are prone to wrong selling because of a high commission structure.
Taxation of MIP’s
Short term capital gains: All short term capital gains which are made by the investor within a year of entering the fund are added to his income and taxed at per his tax slab.
Long term capital gains: Any profit the investor makes after one year in an MIP would be taxed at 10% without indexation or 20% with indexation, whichever is lower.
Short term and long term capital loss: In case of a loss, MIPs can be used against income or profits and used for lowering income and hence, tax.
Dividends: Investors do not have to pay taxes on dividend; however, it is taxable for the company as distribution tax.
Who should Invest in MIPs ?
- Investors looking to earn regular income.
- Conservative investors looking to earn better returns.
- Investors who want to park a big sum of money.