Wise Wealth Advisors

D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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MIP Taxation

Posted by Muthu on July 13, 2014

You would have seen and read a lot about budget. Since these days budget is widely covered I don’t want to repeat the salient features but clarify one point which some of you called and asked me.

So far for the first year, MIPs are taxed at the tax slab you belong to and from 2’nd year onwards at a flat rate of 10%. Accruals are tax free and the taxation arises only at the time of withdrawal. There is no TDS (Tax Deducted at Source) also.

What has changed?

From now on, MIPs would be taxed at the tax slab you belong to for the first 3 years and from 4th year onwards the taxation rate would be 20% with indexation. Indexation means adjusting for inflation. So the actual tax rate would be significantly lesser than 20%.

To illustrate:

Let us assume you’ve invested Rs.1 lakh in a MIP scheme in March 2011. Let us also assume you got an annualized return of 10% and is withdrawing the same in April 2014.

Cost of inflation index for 2010-11 is 711
Cost of inflation index for 2014-15 is 1024

So Rs.1 lakh adjusted for inflation is 100,000/ 711 * 1024= Rs.1,44,022/-

At 10% returns, your MIP would have become Rs.1,33,100/-

Since the MIP value is lesser than inflation adjusted capital, there is zero tax liability for you.

My guess is that if inflation is high, you may have negligible or even no tax and if inflation is low or moderate, you may have significantly lesser tax (than the rate of 20%).

What has not changed?

The accruals continue to be tax free (i.e.) taxation is applicable only when you actually withdraw the gains. As long as you let it grow, there is no taxation. As you are aware, FDs are taxed on accruals every year.

There would be no TDS (Tax Deducted at Source). In MIPs, you’ve to declare the gains and pay taxes unlike FDs where the tax would be deducted at source and you would be paid only the balance.

What you should do now?

The minimum holding period we suggest for MIPs is 5 years. There is no change to that. We ask you to start SWP (Systematic Withdrawal Plan) from 13th month onwards so that there would not be any exit load. Even now you can continue to do the same. However from 13th month to 36th month, the tax rate would be the tax slab you belong to. From 37th month onwards, it would be 20% with indexation (which as explained above would be lesser than 20%).

I also want to highlight one more point. The SWPs of MIPs, each withdrawal, has a principal and an interest (gain) component. The tax would be applicable only on the gain part and not on the principal part. So you don’t pay tax on the entire withdrawals but only on the gain part.

So despite the changes in taxation in the recent budget, MIPs continue to be attractive.

On top of all these, MIPs are capable of giving returns superior to fixed deposits and many of you know this from your past investment experience itself. Though past returns do not guarantee future, it is a pointer for the potential and possibility.

If you need any further clarification, please feel free to call or write to me.

One Response to “MIP Taxation”

  1. ajay said

    Dear Mr. Muthu,

    I admire your simple writings through this blog. In case of MIP I beg to differ from you. I myself I have invested in the MIP for 5years and after the 5year period when I calculated, I found it is better to invest yourself a 25% in direct equity mutual fund like HDFC Equity or Quantum or Frankklin Prima Plus kind and invest the remaining 75% in a Dynamic Bond Fund like Birla Sunlife Dynamic Bond. This will be more tax efficient (specially in the past and even now). For asset allocation just maintain this 75 – 25% ad adjust whenever there is a deviation of say 3% or even 5% on either side. For SWP, you can withdraw from debt funds. , if required. Why to pay a tax for 25% equity by being in a MIP.

    Moreover most of the MIP debt portfolio are very passively managed and a dynamic fund does a better job in a 5year period.
    If you want to add more fund, then too go ahead and add in the same proportion to make your asset allocation to 75-25%.

    Well you may say it is quite difficult for most of the investor. It is just spending few minutes in a month or even a quarter and its not rocket science.

    Regards

    Ajay,

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