Post-retirement, a consistent cash flow is essential. For monthly income, many seniors invest in fixed-income assets like government securities (G-secs) or fixed deposits (FDs) which are very common and popular options. However, some advisors advise seniors to allocate a portion of their portfolio to equity mutual funds to take advantage of the best growth prospects and control inflation.
Apart from Interest income from FDs, there are two other options available. The first option is a Dividend from Stocks or Mutual Funds, and another option is a withdrawal of money through a Systematic Withdrawal Plan (SWP).
All these options provide cash flows, but which one should senior citizens opt for?
Interest on Fixed Deposits or Bonds
Fixed Deposit is one of the most popular traditional options that first comes to mind when a senior citizen intends to invest their money.
The interest rate on FDs or bonds is fixed and therefore interest income is predictable. Your initial investment amount is constant in the case of FD/Bonds. At present, FD offers between 7%-9% interest.
Bonds can offer interest rates between 7%-11%. The higher the interest rate, the higher the risk in the bonds.
Dividends from Stocks or Mutual Funds
Dividend income is related to the Share Market as we get the dividend from Stocks or Mutual Funds. The main difference between interest and dividend is that interest is a specific (%) we get on the principal amount and dividend we get from the part of the profit.
Assume that we have invested the money in the stock of a particular company. Now, when that company makes a profit, it distributes a part of that profit to its shareholders. This is nothing but the dividend. Similarly, if we have invested money in a Mutual Fund scheme, that scheme further invests money into stocks, and this way MF scheme also makes a profit from the share market and distributes it proportionately to the investors.
Please note that the (%) of dividends is less predictable as compared to interest. Though many MF schemes offer predictable (%) dividend Y-O-Y basis, however, it is not completely guaranteed.
Dividends from shares can offer you 0.50% to 8%. The range is wide as it depends on the management of the company. Mutual Funds schemes also offer dividends from 7%-11%.
Systematic Withdrawal Plan (SWP)
In the case of SWP, an investor invests lump sum money in a Mutual Fund scheme and decides how much amount to withdraw every month, as a monthly income.
Here, the withdrawal amount can come from total profit or at times, profit plus the principal amount of investment. If the profit amount is less than your withdrawal, then the part of your principal will get redeemed.
As the investor decides the withdrawal amount, it is completely predictable. However, the performance of that scheme is also should be looked at.
The important thing to keep in mind is, you should not withdraw a very large amount, as it will erode your capital. For example, if your portfolio is already negative and you are withdrawing money from it, then it is of no use. You are just redeeming your capital. In this case, your portfolio will not grow.
To overcome this, you can delay your withdrawal and give some time to grow your portfolio, and then you can start withdrawing systematically.
Taxation in Interest income, Dividend and SWP
Interest income & Dividend
- Interest income will be added to your other regular monthly income and will be taxed as per your applicable tax slab. Hence, if your income falls under 30% tax-slab, you will have to pay 30% tax on interest income as well. But, if your income is below the tax bracket (if you are not liable to any tax), you don’t have to pay any tax on the interest.
- Earlier, dividends were tax-free in the hands of the investors. However, at present the rule has changed and now it is taxable. Similar to interest income on FDs, dividend gets added to your income and charged as per the applicable tax slab.
- Hence, if your income is below the tax exemption limit or in a low tax bracket (5%-10%), interest and dividend options can be beneficial for you. Whereas if you are in a higher tax bracket i.e. 20% or 30%, then you will have to pay taxes accordingly.
Withdrawing through SWP
- In an Equity instrument i.e. SWP, Long-Term Capital Gain (LTCG) and (Short-Term Capital Gain) concepts are applicable. If you are withdrawing money in less than one year, then STCG will attract which is 15%. Otherwise (if you withdraw money after one year), LTCG will attract which is 10% over and above Rs. 1 Lakh.
- The rates of STCG and LTCG (15% and 10%) are not related to your existing tax-slab rates. These rates are independent.
- Hence, even if you are earning more than Rs. 15 Lakhs and paying 30% taxes, the SWP option can be better for you. You will have to pay a maximum of 15% STCG. Further, if you withdraw money after one year, only 10% LTCG will attract above Rs. 1 lakh, which otherwise would have been 30%.
- On the contrary, if your earnings are less than Rs. 5 Lakhs and no tax is applicable for you even after the addition of this regular income (it can be used as monthly income), then the SWP option is not the best. In that case, you can go for the interest or dividend option.
Returns & Risk (%) of interest, dividend & SWP are different. Hence, while investing in products, an investor should allocate the funds in a manner to get the required amount, risk is also balanced & taxation is minimal.
Inflation is also crucial hence investing the entire amount in Debt (FD/Bonds) may not suffice the purpose. Additionally, capital protection also matters, hence, investing entirely in SWP / MFs is not recommended. Balance is the key!