Monthly Income Plan- A Quick Guide to Monthly Income Scheme
Among the various types of debt funds available in the market, one of the most popular has been the Monthly income plan or MIP. While MIPs as a debt product gives higher returns than traditional bank FDs, they are not an assured return product, as is normally perceived. Let us delve deeper into MIPs.
At the outset, MIP is not an assured income product nor a recipe for getting higher returns. MIPs outperform traditional avenues of fixed income investments like bank FDs and corporate FDs but they come with their own set of risks.
Can you explain the concept of monthly income plan (MIP)?
An MIP is a debt oriented fund that pays out dividends on a regular basis. The choice is yours and you can either opt for a monthly income plan or a quarterly income plan depending on your need. However, it must be noted that MIPs only give an in principle commitment to distribute dividends, although MIPs are only allowed to distribute dividends to fundholders only out of the income earned on the instruments held by them. They cannot pay dividends out of capital.
In terms of asset mix, MIP invests mainly in debt instruments and a small portion of 20-25% in equity. Why this equity component and does it not impact predictability? The equity is for the alpha and thus enhances the returns on the MIP compared to traditional debt funds. However, the substantial debt portion is sufficient to pay out the regular income.
In the recent past, MIPs did lose a lot of their attractiveness due to the dividends being made fully taxable in the hands of the investor. However, many funds do structure these pay-outs as systematic withdrawals or as SWPs so as to make the MIPs more tax efficient. That way, there is also no restriction on pay-outs of dividends.
What are the major highlights of a monthly income plan?
Conceptually, MIPs are debt funds that are predominantly invested in debt with a small component in equity for alpha. However, they give a commitment of regular income payment and that makes it attractive for retired persons who rely on their investments to earn them income on a regular basis. Here are some major highlights of the MIP.
- MIPs can only declare dividends out of profits made by the fund and no pay-outs can be made from capital. However, this requirement can be tweaked by structuring the MIP as a systematic withdrawal Plan.
- How does an MIP earn profits or income on its investments? Profits for an MIP comes from 4 sources viz. interest on debt instruments, profits from debt trading, dividends on equity and profits on equity trading.
- MIP is not an assured return scheme, as is popularly believed. If the performance is negative, then there will be no monthly or quarterly income paid out and that is a risk you bear when you invest in MIPs. SEBI has underlined that MIPs are investor’s risk.
- Being a hybrid of equity and debt, the MIPs are subject to debt market and equity market risk. On their debt component, they typically run interest rate risk and default risk. On equity holdings they run the market and stock risk.
- An MIP is a trade-off. The equity exposure (albeit small) enhances the returns but also exposes the performance of MIP to vagaries of the stock market. Of course, the primary driver of MIPs are still the debt fund performance.
- MIPs are invested in slightly higher yield and higher duration instruments and hence have a strong interest rate risk in them. These MIPs benefit from falling interest rates and see capital erosion if interest rates rise.
Are MIPS taxable or are they tax-free?
Remember that the Income Tax Act, for the purpose of taxation of mutual funds, only makes a classification of equity funds versus non-equity funds. MIPs would classify as non-equity funds. They are subject to tax at different points like other non-equity assets.
- Dividends declared by the MIP used to be tax-free in the hands of the investor but were subjected to 25% DDT. Now the DDT has been scrapped but dividends are taxable as other income in the hands of the investor and taxed at the peak rate.
- Short term capital gains on MIPs used to be 1 year in the past, but not it is 3 years. Only beyond 3 years, the MIPs are long term capital gains. This shift in treatment of capital gains has made MIPs less attractive to many debt investors.
- Long term capital gains on MIPs, held for a period of more than 3 year, are taxed at a concessional rate of 20%. In addition, they also get the benefit of indexation if held for more than 3 years.
- Losses on MIP can be either set off against gains or can be carried forward for a period of 8 years for future set-off. However, long term losses can be only set off against long term gains while short term gains can be set off against LTCG and STCG.
- MIPs can be used for double indexation benefit by buying towards the end of the fiscal year and selling a little above 3 years in the fourth financial year. This reduces the tax applicable on capital gains.
Do MIPS add value for investors seeking regular income?
A couple of points to remember here. On the one hand, dividends on MIPs are not technically assured, but as a matter of policy most MIPs make it a point to pay out regular dividends to take care of the market expectation. This product makes a lot of sense for retirees and others seeking regular income as MIPs give above average returns.
Therefore investors seeking regular income and an investment horizon of 3-4 years, can invest in MIPs. They have worked as the best option in terms of risk-adjusted returns. However, MIPs are subject to mis-selling so don’t buy the assured returns sales pitch. However, with SWP structuring, they can still be a good instrument.
Remember, dividends on MIPs are not technically assured but as an unwritten principle, MIPs do tend to ensure that dividends are paid out at regular intervals. If you are looking at a conservative asset class with some alpha from equities, then MIPs are a really good option. You should ideally structure it as a SWP to make it tax efficient.