Introduction
For investors looking to balance safety, regular income, and moderate growth, a monthly income plan (MIP) is often a popular choice. These hybrid mutual funds primarily invest in debt instruments while allocating a smaller portion to equities, aiming to provide a steady income stream along with some growth potential. While the return aspect of MIPs is widely discussed, one equally important factor for investors is taxation. After all, tax efficiency can significantly impact your actual take-home income and long-term wealth creation.
So, what are the tax benefits of a monthly income plan? Can they help you reduce your overall tax liability while generating stable returns? In this article, we’ll dive deep into the taxation rules for MIPs in India, explore their advantages compared to other investment options, and provide strategies to maximize their tax benefits.
Understanding Monthly Income Plans (MIPs)
Before analyzing tax implications, let’s quickly revisit what an MIP is:
- Investment Composition: Roughly 70–85% in debt securities (like bonds and debentures) and 15–30% in equities.
- Income Option: Offers dividend payouts that mimic a monthly paycheck.
- Growth Option: Reinvests returns to build wealth through compounding.
- Risk Level: Moderate risk, as it balances fixed-income stability with limited equity exposure.
Since MIPs are classified under debt-oriented mutual funds (because debt allocation exceeds equity), their taxation follows debt fund rules.
Taxation Rules for Monthly Income Plans
1. Dividend (Payout) Option
- Until 2020, dividends from MIPs were tax-free in the hands of investors, as the fund house paid Dividend Distribution Tax (DDT).
- After April 2020, the taxation framework changed:
- Dividends are now added to the investor’s income.
- They are taxed as per the investor’s applicable income tax slab rate.
- For example, if you fall under the 30% slab, dividend payouts from your MIP will also be taxed at 30%.
- TDS (Tax Deducted at Source): If dividend income from MFs exceeds ₹5,000 in a year, AMC deducts 10% TDS before payout.
Implication: The dividend option is not tax-efficient for investors in higher tax brackets.
2. Growth Option (Capital Gains Taxation)
When you choose the growth option, you don’t receive regular payouts. Instead, the gains remain invested and compound over time. Tax is applicable only when you redeem (sell) your units.
- Short-Term Capital Gains (STCG):
- If redeemed within 36 months (3 years) of investment.
- Taxed as per your income tax slab.
- Long-Term Capital Gains (LTCG):
- If held for more than 36 months.
- Taxed at 20% with indexation benefit.
- Indexation adjusts your purchase price for inflation, reducing your taxable capital gain significantly.
Example:
- Suppose you invested ₹5,00,000 in an MIP in April 2018.
- You redeem it in April 2022 for ₹6,50,000.
- Nominal profit = ₹1,50,000.
- With indexation, your purchase price (inflation-adjusted) might be considered ₹5,70,000.
- Taxable profit = ₹80,000 (not ₹1,50,000).
- LTCG tax = ₹16,000 (20% of ₹80,000).
Without indexation, you’d have paid tax on the full ₹1,50,000. This highlights why MIPs under the growth option are tax-efficient for long-term investors.
Tax Benefits of Monthly Income Plans
1. Indexation Advantage for Long-Term Investors
The indexation benefit is the biggest tax perk of MIPs. It helps reduce taxable gains by adjusting for inflation, ensuring you don’t pay tax on “illusory” profits caused by rising prices. Over long horizons, this can save substantial tax.
2. Lower Tax Burden Compared to Fixed Deposits
- FD interest is taxed annually at slab rates, regardless of whether you withdraw it or not.
- MIP growth option defers taxation until redemption, giving you the benefit of tax deferral and compounding.
- Over time, this difference makes MIPs more tax-friendly than FDs, especially for investors in higher tax brackets.
3. Flexibility in Tax Planning
- With the growth option, you can control when to redeem and incur tax.
- You can plan redemptions in financial years where your income is lower, reducing tax liability.
4. No TDS on Growth Option
Unlike dividend payouts, the growth option doesn’t attract TDS. This means your returns stay invested without deduction until you decide to withdraw.
Comparison: Taxation of MIPs vs. Other Instruments
| Investment Option | Taxation Type | Tax Rate | Benefit/Drawback |
|---|---|---|---|
| Fixed Deposits (FDs) | Interest taxed annually | As per slab | No deferral, no indexation |
| Monthly Income Plan (Dividend) | Dividends taxed annually | As per slab | TDS applies above ₹5,000 |
| Monthly Income Plan (Growth) | Capital gains tax on redemption | 20% with indexation (LTCG) | Deferral + inflation adjustment |
| Equity Mutual Funds | LTCG tax after 1 year | 10% (above ₹1 lakh) | No indexation |
| PPF/EPF/SSY | EEE (Exempt-Exempt-Exempt) | Nil | Very tax efficient, but limited liquidity |
| NPS (National Pension System) | Partially taxable on withdrawal | Mixed | Long lock-in |
Who Benefits the Most from MIP Taxation?
- High-Income Investors – Instead of paying slab-rate taxes on FD interest, they benefit from indexation on MIPs.
- Long-Term Investors – Holding beyond 3 years maximizes the LTCG indexation benefit.
- Retirees Seeking Stability – Can opt for a mix: growth option for tax efficiency and systematic withdrawals for monthly income.
- Tax-Sensitive Investors – Those who want to defer tax liability and control redemption timing.
Strategies to Maximize Tax Benefits of MIPs
- Prefer Growth Over Dividend Option
- Growth ensures compounding and defers tax until redemption.
- Dividend option may hurt investors in higher tax slabs.
- Hold for More Than 3 Years
- To qualify for LTCG and enjoy indexation benefits.
- Avoid frequent withdrawals that attract STCG.
- Systematic Withdrawal Plan (SWP)
- Instead of opting for dividends, set up an SWP from your growth plan.
- SWP withdrawals are treated as redemptions, with part principal and part gain—leading to lower tax compared to full dividend taxation.
- Use MIPs Alongside Other Tax-Saving Instruments
- Combine with PPF, NPS, or ELSS funds to balance tax efficiency and liquidity.
- Redeem Strategically
- Time redemptions in years when your taxable income is lower (e.g., post-retirement), reducing tax liability.
Common Misconceptions About MIP Taxation
- “Dividends are tax-free.”
False. Since April 2020, dividends are taxed at slab rates. - “All mutual funds have the same tax rules.”
Not true. MIPs (debt-oriented) differ from equity funds, which enjoy 1-year LTCG benefits. - “MIPs provide guaranteed monthly income.”
Misleading. Payouts are not fixed and depend on the fund’s performance. - “Tax is avoided, not deferred.”
Wrong. Growth option defers tax until redemption, but it still applies when units are sold.
Practical Example: MIP vs. FD Over 5 Years
- FD Investment: ₹10,00,000 at 7% p.a.
- Interest earned in 5 years = ₹3,50,000.
- Tax (30% slab) = ₹1,05,000.
- Net gain = ₹2,45,000.
- MIP (Growth Option): ₹10,00,000 at 8% p.a. compounded.
- Corpus after 5 years = ₹14,69,000.
- Indexed purchase price = ~₹11,80,000.
- Taxable gain = ₹2,89,000.
- Tax @20% = ₹57,800.
- Net gain = ₹3,11,200.
Clearly, the MIP offers better post-tax returns than FDs due to indexation and deferred taxation.
Conclusion
A monthly income plan not only provides regular income and moderate growth but also offers meaningful tax advantages when chosen wisely. The real tax benefits lie in the growth option, where long-term capital gains with indexation can significantly reduce your tax liability. Compared to fixed deposits and other traditional instruments, MIPs are far more tax-efficient, especially for long-term and high-income investors.
That said, MIPs are not tax-free—they only defer and optimize taxes. To maximize benefits, investors should:
- Choose growth over dividends.
- Hold investments beyond 3 years.
- Use SWPs strategically for regular income.
With smart planning, monthly income plans can help you not only earn steady returns but also keep more money in your pocket after taxes—making them a powerful tool in your financial strategy.