Can Mutual Funds Earn You Regular Income

When it comes to investing, senior citizens, in particular, look for earning a regular income that can take care of their retirement expenses.

The common choice, of course, is bank fixed deposits and small savings schemes, among others. But now, with mutual funds having showcased their return potential, many investors are interested in knowing if they can earn a regular income from them.

You see, mutual funds provide the dividend option (now known as Income Distribution Cash Withdrawal or IDCW option). However, the dividend in mutual funds is unlike dividends in stocks.

In stocks, when the company makes a profit, it usually declares a dividend for its shareholders.

Whereas, in the case of mutual funds, even if it may be investing in dividend-yielding companies, the scheme may not necessarily declare dividends for its unitholders.

The fund manager may decide to reinvest or accumulate the dividend received in the scheme portfolio to benefit from the compounding of wealth.

Hence, dividends by a mutual fund are completely at the discretion of the fund manager. For this reason, and to ensure clarity among investors, the capital market regulator renamed the divided option to 'Income Distribution Cash Withdrawal' option.

A mutual fund scheme may declare an 'income distribution' out of the gains made, as and when the fund manager deems appropriate.

So, dividend payments by mutual funds are not guaranteed. It is subject to the fund's performance and discretion. In other words, there is no surety of earning a regular income when you opt for the IDCW option.

When a mutual fund declares a dividend, its NAV under the IDCW option goes down to the extent of the distribution amount.

Even if you opt for dividend-yield mutual funds (which are mandated to invest a minimum of 65% of their assets in equity & equity-related instruments of dividend-yielding companies), it is not always true that the dividend earned by the fund will be distributed to you.

So, then how can one earn regular income with mutual funds?

The answer is by sensibly using the Systematic Withdrawal Plan (SWP).

Systematic Withdrawal Plan (SWP)

SWP is a facility extended by mutual fund houses to you for withdrawing money from a scheme systemically - monthly, quarterly, biannually, etc.

You need to first invest in a mutual fund scheme and then use a Systematic Withdrawal Plan (SWP) to withdraw a certain amount.

Keep in mind, there is no such thing as best SWP mutual funds. You need to choose among the best and the most suitable ones to invest in and then do SWP.

The amount you withdraw using the SWP route can be fixed or variable, as per your choice.

The withdrawn amount provides periodic income, while the balance, not withdrawn yet, continues to earn you returns. In other words, there is potential for the growth of your capital along with the income from the SWP.

The systematic and disciplined withdrawal process provides cash flow without having to sell and exit your mutual fund investment. You benefit from rupee-cost averaging and compounding.

However, when using SWP, you need to be careful about the withdrawal rate, i.e. to say how much you withdraw from the fund.

Remember, a higher withdrawal rate could end up exhausting the value of the corpus built. Hence, the withdrawal rate for SWP should be optimal.

The Thumb Rule for SWP Withdrawal

Well, a 4% per annum SWP withdrawal rate may serve you well.

Meaning, 4% per annum of the accumulated corpus in a mutual fund scheme/s can be withdrawn.

However, this should ideally be used when a sufficient investment corpus is generated over the years - and not when you have just begun your investment journey.

SWP is suitable for retirees to address expenses during the golden years of life. But it also depends on your retirement corpus.

Calculating Retirement Corpus Using the 4% Thumb Rule

Current Monthly Expenses (Rs) (a)	60,000
Inflation p.a. (assumed)	6%
Years to Retirement	5
Expected Monthly Expenses at Retirement Age (Rs) (b)	80,294
Annual Expenses (Rs) (c) = (b) x 12 months	963,522
Retirement Corpus Required (Rs) (d) = (c/0.04)	24,088,060

The table above is for illustrative purposes only.

Say, your monthly expenses currently are Rs 60,000, inflation is 6% per annum on average, and you have 5 years before you hang up your work boots.

Your monthly expenses are likely to increase to approximately Rs 80,000 (annually around Rs 9.6 lakh). So, your retirement corpus must be at least Rs 24.1 million.

A 4% p.a. withdrawal rate shall ensure that your corpus lasts you till you turn older.

Impact of Withdrawing at 4%

Age	Opening Bal. Corpus at Retirement	Annual Expenses (assuming inflation @6%)	Expected Annual Return @ 8%*	Closing Bal. of Retirement Corpus
60	24,088,060	963,522	1,927,045	25,051,583
65	29,077,254	1,289,410	2,326,180	30,114,024
75	39,045,476	2,309,138	3,123,638	39,859,976
80	42,233,929	3,090,147	3,378,714	42,522,496
85	41,799,198	4,135,314	3,343,936	41,007,820
90	34,309,238	5,533,982	2,744,739	31,519,994
95	14,135,579	7,405,717	1,130,846	7,860,709
96	7,860,709	7,850,060	628,857	639,506
97	639,506	8,321,064	51,160	-7,630,397

*Expected annual return considered 8% p.a. on a conservative basis.
he table above is for illustrative purposes only.

In the above case, your retirement corpus would last you until your retirement age of 96.

If you keep the withdrawal rate higher, it may last you only until the age of around 85-86. In such a case, if you outlive, you will not be able to build your retirement expenses with the corpus built.

Be Mindful of the Tax Impact

If you have opted for the IDCW option of a mutual fund, the dividend or the income distribution received will be taxable as per your income tax slab.

If the dividend income exceeds Rs 10,000 for an individual, tax will be deducted at source (TDS) at 10% in case of resident individuals (with PAN) and 20% in case of NRIs.

When the SWP route is taken, withdrawals would be subject to capital gains tax.

As per the current tax rules, the gains from an equity mutual fund investment, if withdrawn within 12 months from the date of investment, are treated as Short Term Capital Gains (STCG) and taxed at 20%.

If the investment is withdrawn after 12 months, the gains are called Long Term Capital Gains (LTCG) and are taxed at 12.5%, if more than Rs 1.25 lakh in a financial year.

If it is a debt mutual fund scheme from where you are doing systematic withdrawals, the net gains will be added to your gross total income (GTI) and taxed as per your income-tax slab.

Conclusion

To earn a regular income from your mutual funds, first make sure you have built a sizeable corpus over the years.

Make a conscious effort to improve your saving rate and ensure that it is invested sensibly in not just the best mutual fund scheme but also the most suitable one for you.

Thus, you can earn effective inflation-adjusted returns and accomplish your financial goals.

Be a thoughtful investor.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a recommendation and should not be treated as such.