How to earn higher regular income

Bank deposits, post office deposits and senior citizen schemes are among the well-known investments where people park their money to get a regular income. But what about returns after you factor in income tax?
Interest income from these investments are added to your income and taxed according to your tax slab. Investors in higher tax brackets can look at the other tax-effective investments, say financial planners. But “consistency of income and preservation of capital both are equal objectives in the strategy of income generation investment models,” says Manoj Nagpal, chief executive officer of Outlook Asia Capital.
Monthly income plans (MIPs): Monthly income schemes of mutual funds, which are predominantly debt schemes with a small equity component, used to be a popular avenue to earn regular income. But tax changes in 2014 took the sheen off the schemes. In 2014, Finance Minister Arun Jaitley increased long-term capital gains tax on debt mutual funds from 10 per cent to 20 per cent, while the holding period for qualifying as long term went up from 12 to 36 months.
However, financial planners say that MIPs are still good instruments to earn regular income. But they require some planning from the part of investors. Investors need to invest in MIPs for at least three years to earn a tax-efficient regular income. Returns made on MIPs after three years are subjected to 20 per cent tax but they can be adjusted against cost of inflation, thus reducing the tax impact to negligible levels. A systematic withdrawal plan can provide a regular stream of income.
“MIPs from mutual funds over the years have changed their character from a low equity allocation of 5-15 per cent to 20-25 equity exposure, thus increasing variability in returns. But it still remains a good choice for investors,” says Nagpal of Outlook Asia Capital.
Equity income/savings funds: These new breed of mutual funds invest in equity, equity derivatives and debt securities. Equity exposure is partly hedged with corresponding equity derivatives. To get the tax benefit of equity funds, these funds maintain an exposure of at least 65 per cent in equity and equity derivatives. This means the capital gains of investors who put their money in these funds for over a year are not taxed. Investors can choose the systematic withdrawal or dividend option (dividends from these funds are also tax-free). Since these funds are of a recent origin, they don’t have much of a track record.
While equity income funds could be a smart way to save taxes, Vidya Bala, head of mutual fund research at FundsIndia, says that only savvy investors who understand the underlying functioning of the scheme should look to invest in these funds. Since some part of the equity is not hedged, investors should be comfortable with the equity part of investment, she adds.
Corporate deposits: Interest rates on corporate deposits are usually higher than bank deposits. And just like bank deposits, they offer several payout options – like monthly and quarterly. However, investors need to pay close attention on the corporate’s profile and the deposit’s credit ratings. “Company fixed deposits (FDs) still provide around 1-2 per cent higher than bank FDs, with the AAA-rated company FDs like that HDFC among other are suitable options for regular income generation on a pre-tax basis,” says Mr Nagpal of Outlook Asia Capital.
Bonds: Tax-free bonds, which were issued by government-owned entities in the past few years, were a huge hit among investors who looked for a steady tax-free interest income. This financial year, however, there would not be fresh issues of tax-free bonds. Since tax-free bonds are traded on exchanges, investors looking to put money in these bonds can buy them from secondary markets.
Vikram Dalal, managing director at Synergee Capital Services, says tax-free bonds are a good alternative for investors in higher tax brackets. One of his recommendations is 7.69 per cent HUDCO tax-free bonds with maturity in 2031 (currently quoting at Rs 1,095.50). The bond’s yield to maturity works out at 6.65 per cent which means a pre-tax return of 9.93 per cent, he says.
In comparison, SBI currently pays 7 per cent on five- to ten-year fixed deposits. The yield to maturity is the return on investment earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity. However, investors putting their money in tax-free deposits should keep the liquidity factor in mind. Some tax-free bonds are not traded frequently.