The name “Monthly Income Plan” is certainly a misnomer. There is no guarantee of monthly income (and the quantum of income). Hence, MIPs are nowhere similar to Post Office Monthly Income Schemes (POMIS).
What are Monthly Income Plans (MIPs)?
Monthly income plans are hybrid mutual funds that primarily invest in debt securities. Exposure to equity is typically limited at 15-25% of the net assets. And that’s it.
In my opinion, smart marketing managers have tried to present MIPs as something it is not.
Here is what is mentioned as investment objective for HDFC MF Monthly Income Plan.
To generate regular returns through investment primarily in Debt and Money Market Instruments. The secondary objective of the Scheme is to generate long-term capital appreciation by investing a portion of the Scheme’s assets in equity and equity related instruments. Monthly Income is not assured & is subject to availability of distributable surplus.
Hence, do not go by the nomenclature and find out about how scheme invests and if the scheme is a fit with your portfolio.
Taxation of Monthly Income Plans (MIPs)
Since the equity exposure of MIPs is much less than 65%, MIPs are debt mutual funds in the eyes of the taxman.
Hence, short term capital gains (holding period <=3 years) are taxed at your marginal income tax rate (slab rate).
Long term capital gains (holding period > 3 years) on sale of such units is taxed at 20% after indexation.
If you opt for dividend option, dividend distribution tax (DDT) will also be applicable. DDT is applicable at 25%. After considering cess and surcharge, the effective taxation is 28.84%. This rate is irrespective of your income tax slab.
Do note this tax is deducted by the AMC on your behalf. Tax is paid from your money only.
You do not have to pay any tax on such dividend from MIP. Dividend is tax-free in the hands of the investor.
Who should opt for Monthly Income Plans?
In my opinion, since there is an element of equity exposure, do not invest in Monthly Income Plans if your investment horizon is less than 5-7 years away.
Moreover, MIPs should only be part of your growth portfolio.
You must use debt mutual funds or other debt investments for your income requirements.
Do not fall for the nomenclature.
Do not look at MIPs if you need regular income.
Therefore, the previous section about the choice between Growth and Dividend is not really needed (if you agree with my assessment). If you invest in MIPs only for the long term, you are better off investing in Growth option.
If you are comfortable with volatility and have investment discipline, there is no need to invest in MIPs. You can construct a portfolio yourself (using an equity and a debt fund). You will have better control over the portfolio too.
MIPs can be a good option for investors who find it difficult to digest volatility. Such funds, given the high debt exposure, are likely to be less volatile than equity funds.
Do note it does not mean you cannot suffer loss in a Monthly Income plan. You can still suffer loss.
Retired or those who are about to retire can consider these funds for their long term needs.
Additional point to note is that the level of equity exposure that a MIP can take is not defined anywhere. You need to refer to scheme information document to figure out. Higher the equity exposure, greater the volatility.
Additionally, you need to figure if its debt component will act like an ultra-short term debt fund, short term debt fund or a long term debt fund or there is an alternate strategy. Not easy to figure even after reading Scheme Information document. You may need to look at actual portfolio to make an assessment.
For instance, ICICI Prudential Monthly Income Plan can take up to 15% exposure in equities. ICICI Prudential MIP 25, another MIP from ICICI Prudential stable, can take up to 30% exposure in equities. You can expect the risk return profile of these two funds to be quite different.
HDFC Monthly Income Plan can invest up to 50% of its net assets in Foreign Debt securities.
If you are planning to invest in MIPs, you must go through Scheme Information Document to see if the fund is in line with your requirements.
Personally, I do not invest in MIPs and do not plan to invest in such funds in near future. However, this is a mere personal preference. Many investors, and rightfully so, can find merit in MIPs.
Dividend or Growth?
In most cases, growth option is likely to be a better choice.
There are multiple reasons behind it.
Even if you are looking for regular income, you may be better off investing in growth option and selling those units as and when required.
Dividends are not guaranteed. There are also certain limitations on when a mutual fund can pay dividends. During periods of under-performance, the fund’s ability to pay dividend might be limited. Hence, you may not get dividend when you want it. In such a case, you will have to redeem a few units when you need the money.
Since Monthly Income Plans qualify as debt funds from tax point of view, dividends are effectively taxed at 28.84%.
If you happen to hold units for greater than 3 years, any sale of units will be taxed at only 20% after indexation. If you are not looking for regular income, Growth is a much better option.
For taxpayers in the 10% and 20% tax bracket, it makes no sense to invest in Dividend option. Why will you pay a tax of 28.84% (indirectly by opting for dividend option) when you can opt for Growth option and pay much lesser tax. Invest in Growth option and redeem as and when needed.
Even for taxpayers in the 30% tax bracket, it may be prudent to go for growth option in a few cases. In case of dividend option, dividend tax liability will be on all the units held. Hence, whether you need to funds or not, dividend will be paid by AMC after deducting tax.
If you had picked up growth option and you happen to redeem some of the units, capital gains tax liability (30%, income tax slab in this case) will only be on the redeemed units. It is quite possible you do not happen to redeem some of the units for 3 years. After 3 years, capital gains tax is only 20% after indexation.
If your income in a financial year is above Rs 1 crore, effective short term capital gains tax liability can go up to 34.6% (including surcharge and cess). Dividend tax of 28.84% looks a better option in this case if you foresee entire redemption within 3 years.
Hence, you need to look at your cash flow requirements before making the choice. Growth option is likely to be a better and more flexible choice in most cases.
By the way, the above analysis will hold true for any debt mutual fund.
