The Monthly Income Plans (MIPs) of the mutual funds have majority of investments in the debt instruments so as to make good the promises of monthly income to the investors.
The dividend option of a MIP does not necessarily imply a fixed monthly dividend income, as the law does not obligate compulsory dividend distribution on part of these MIPs. A Systematic Withdrawal Plan (SWP) entails a stable payout to the investors at predetermined intervals. This implies that at some stage the investments will be completely repaid along with the gains.
Going for the dividend option of a MIP would mean that your monthly income would be subject to the dividend declared by the scheme you have chosen to invest in. Though there are few funds viz. FT India MIP-G, DSPML Savings Plus Moderate-G, which have given good returns on a consistent basis but the dividends for most of the funds have not been at a very consistent rate.
A SWP on the other hand, scores better on this count as it provides a stable payout to the investors. If this payout forms a part of living requirements an SWP is definitely a more dependable option. But this would make sense if you invest a big sum at the first go so as to withdraw nominal amounts at the predetermined intervals.
Another cause of concern would be the taxation aspect. Dividend income is free in the hands of the investors so while you do not pay any tax under the dividend option, there is a dividend distribution tax on part of that the dividend distributed by the debt oriented MIPs at the rate of 12.5 per cent (plus surcharges).
In case of a SWP when you opt for a growth plan in the initial years of a SWP, the gain portion is much smaller. Most of the payout actually consists of the principal (investment).
Over time, the principal component of the payout decreases giving way to the gain component. The short term capital appreciation (selling price-cost of acquisition) would be subject to the short term capital gains tax for which the amount of gain would be added to your total income and is taxable at the normal rates of tax as specified in the income tax act as applicable.
The longer-term gains would be charged at the rate of 20 per cent (plus surcharge plus education cess) after taking the benefit of indexation benefits or 10 per cent (plus surcharge plus education cess) without taking the benefit of indexation.
An illustration would make the picture clearer. Assuming an initial investment of Rs 1,00,000 under FT India MIP three years back under the dividend option the fund has given an average monthly dividend of Rs 0.70. The present worth of the Rs 1,00,000 investment on March 1, 2002 would be valued at Rs 1,11,943.10 today. The number of units will remain the same as it was on March 1, 2002 (i.e. 9,479 units). The dividend payment in the three years would total up to Rs 23,886.26.
The total sum would be Rs 1,35,829.40 as of March 1, 2005. In the second option of a quarterly withdrawal of Rs 2,000 under the growth option of the same scheme would decrease the number of units from 8,333 three years back to 6,672 today.
The worth of this investment would be Rs 1,14,939.08 and a total of Rs 24,000 as the quarterly withdrawals would add to Rs 1,38,939.08. So we see that under the second option of a SWP you not only get Rs 3,109.70 more, but also the amount that you withdraw at predetermined intervals is known to you in advance.
So you can plan your expenses better as compared to the dividend option where as seen in this example you got more or less an equivalent amount in a quarter but the rates of dividend varies per month. At the end of one month you may receive Rs 1,421.80 as the dividend and in some other month you may have to feel happy with Rs 335.55 as dividend. So you can not depend on this monthly income to form a part of your living expense.
In the above illustration assuming you are taxed at the rate of 30 per cent the short-term capital gains tax under the SWP would amount to a total of Rs 1,230.30 as per the existing guidelines.
So even if you opt for Systematic Withdrawal Plan you are better of by Rs 1,879.40.If your income does not come under the taxable limits then your gains would be even bigger. In dividend option the scheme has to pay a compulsory dividend distribution tax of 12.5 per cent (plus surcharges).
The difference of the present NAVs under the dividend option (Rs 11.90) and under growth (Rs 17.23) accounts for the facts that on every declaration of dividend the NAV falls and the company pays the dividend distribution tax.
This article was originally published on May 10, 2005.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
