29 May 2017 09:47:01 IST

Choosing between regular income options

Weigh safety, liquidity, returns and tax-efficiency to make an informed choice

Newfangled instruments are popping up everyday, but if you’re looking for a predictable monthly income, without giving away a pound of flesh to the taxman, the choices are still limited. We decided to face off the different products to help you choose.

Playing it safe

If safety of your capital and rock-steady income is your priority, the Post Office Monthly Income Scheme (POMIS), Senior Citizens Savings Scheme (SCSS) and immediate annuity plans from insurers are the choices.

Bank FDs usually accumulate your interest until maturity, but some banks offer a monthly/quarterly payout option on term deposits at a lower interest rate. After a series of cuts, interest rates on one-year-plus bank FDs now hover at 6.5 to 7 per cent. The monthly income deposits are for one to 10-year terms, though locking in for more than two years does not fetch you a higher interest rate. Premature withdrawals are allowed after a 12-month lock-in with a penalty of 1-2 per cent. The interest is added to your income and taxed at your slab rate, so your interest income of 6.5 per cent gets trimmed to 4.8 per cent at a 30 per cent tax and to 5.6 per cent at 20 per cent on a post-tax basis.

The POMIS, from India Post, today offers a superior alternative to bank FDs giving an annual interest of 7.7 per cent. If you invest before June 30, you can lock into this rate. You can open the POMIS account for five years at a time. Early withdrawal is allowed after one year with a 2 per cent penalty, and after three years with a 1 per cent penalty.

The constraint though, is the ceiling on the total amount you can contribute to the scheme — ₹4.5 lakh as a single holder and ₹9 lakh in a joint account. This caps your annual interest from the scheme at ₹34,650. The interest added to your income and taxed at your slab rate. Effectively, the post-tax return works out to 5.4 per cent in the 30 per cent slab and 6.1 per cent at 20 per cent. While the POMIS interest rate is quite attractive for a sovereign-guaranteed instrument, the cap on investments effectively limits it utility as your key source of monthly income.

If you’re a senior citizen, you must consider the SCSS (open to retirees who are 55 and above) ahead of the above. You can lock into prevailing rates for a five-year period. The current interest rate at 8.4 per cent (April-June 2017) easily tops POMIS. Early withdrawals are allowed after one year, at a 1.5 per cent penalty. While the interest from the scheme is taxable at your slab rate, your initial investment is tax-free under Section 80C. The account limit of ₹15 lakh caps your income at ₹1.26 lakh a year.

Immediate annuity plans from insurers offer another option to secure a lifelong income by investing a lumpsum upfront. Once you ‘buy’ the annuity, the investment is completely hands-free; the monthly income keeps flowing in for as long as you live. But on the flip side, are the low returns, illiquidity and the fact that the income doesn’t change with inflation or market rates. LIC’s Jeevan Akshay VI allows you to earn annual income of ₹6,600 for an upfront payment of ₹1 lakh; that’s an effective pre-tax yield of 7 per cent if you live until 80. On a post-tax basis, that’s 4.8 per cent at the 30 per cent slab and 5.5 per cent at the 20 per cent slab. If you can actively manage your investments, the POMIS and SCSS are your best bets. Immediate annuity plans are best considered when market interest rates are peaking.

With some risk

FDs from NBFCs tend to be the top choice for monthly income seekers because they offer higher interest with a monthly payout. The options here range from the safe AAA-rated issuers, to ones with some measure of default risk. Given the turbulent credit environment, it is best to avoid NBFCs with credit ratings below AA+.

Highly rated NBFCs now pay you 7.25-7.95 per cent for one to five-year deposits. Premature withdrawals are allowed with a 1-2 per cent penalty. They allow you earn better returns than POMIS without any investment limits, but are taxed at your slab rate.

If you are willing to take on some market risks, debt mutual funds can cater to monthly income needs in a more tax-efficient fashion. Here, the so-called Monthly Income Plans (MIPs) aren’t the ideal bet as their ‘income’ is subject to equity market swings. Instead it is best to earn that monthly cash flow by opting for the Growth Plan of a liquid, short-term income or income fund, and setting up a Systematic Withdrawal Plan. Even as units are redeemed to generate this ‘income’, the returns that the fund earns accumulate to the NAV. This is more tax-efficient than going in for the dividend plan (subject to a distribution tax of 28.3 per cent). Returns earned within three years on the Growth Plan are taxed at your slab as short-term capital gains. But if held for three years, indexation benefits help reduce capital gains tax (20 per cent). Ideally, invest three years ahead of your monthly income needs. But if you can’t do this, it is still tax-efficient to take this route because the tax is only levied on the return portion of the units redeemed and not on the entire NAV.

Debt funds can subject you to fluctuating returns due to interest rate and credit risks.

To minimise these, opt for funds with a less than three- year duration and a AA or higher rated portfolio.

(The article first appeared in The Hindu BusinessLine.)