Maximizing Monthly Dividends with Hybrid Funds: A Tax-Efficient Strategy
Investing in mutual funds has been a popular choice for both short-term and long-term financial goals. However, the recent taxation norms have significantly impacted dividend schemes, making them less attractive. In this article, we explore the best options for investing 10 lakh rupees to receive a decent monthly dividend while ensuring tax efficiency.
Understanding the Current Tax Scenario for Dividend Schemes
The introduction of new taxation norms has led to a significant challenge for dividend fund investors. Any dividends received are now fully taxable in the hands of the investor, with a rate of 30% if your taxable income exceeds Rs. 10 lakh in a financial year. This tax obligation is a substantial burden, especially for high-income investors.
It's important to note that dividends are not merely a distribution of income. They often involve a withdrawal from the capital of the investment, leading to double taxation if the dividends are reinvested or distributed in the short term. This has prompted SEBI to guide mutual funds to rename dividend schemes to IDCW (Income Distribution Cum Capital Withdrawal) to clarify the nature of the distributions.
Alternative Investment Options: Equity-Oriented Hybrid Funds
A better alternative to dividend schemes is to invest in equity-oriented hybrid funds and start a systematic withdrawal plan (SWP). SWP provides a more predictable capital inflow from your investments and is far more tax-efficient than traditional dividend schemes. We recommend keeping the withdrawal rate not more than 8%, as the assumption is that the fund will grow at 10-12%. Irrespective of withdrawals, there will also be capital appreciation.
Equity-oriented hybrid funds combine the growth potential of equities with the stability provided by debt allocation. This mixed approach makes them less volatile during market downturns, ensuring that you do not redeem too many units for the same amount.
Numerical Example to Illustrate the Advantage
To better understand the benefits, let's consider a numerical example. Suppose you invested Rs. 10,000,000 in a fund with an initial Net Asset Value (NAV) of Rs. 100. Therefore, you would own 100 units in the fund.
You decide to withdraw Rs. 80,000 annually, which averages to approximately Rs. 6,700 per month. In one of the years, the market was in a downturn, and the average NAV was approximately Rs. 80. In that scenario, you would redeem 10 units overall.
In another year, the market was strong, and the average NAV for your redemptions was Rs. 160. That year, your redemptions would be simply 5 units. In all scenarios, tax is only applicable on the gains with a purchase NAV of Rs. 100. In the first case, since your gains would be negative, there would be no tax. In the second case, your gains would be Rs. 60 multiplied by 5 units, resulting in Rs. 300. Depending on the holding period, this would be taxed at 15% if redeemed in less than a year or at 10% if redeemed after more than a year.
Conclusion
In summary, investing in a mix of equity-oriented hybrid funds and initiating a systematic withdrawal plan is a tax-efficient way to receive a predictable monthly dividend. While the market fluctuates, the hybrid fund structure ensures that your capital appreciates even as you receive consistent income. This strategy strikes a balance between growth and stability, making it an ideal choice for those seeking a steady income stream from their investments.