SWPs in debt funds best after retirement

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Most people who don't have access to professional advice invest the funds received on superannuation in bank/post office fixed deposits, earning around 9% per annum on a pre-tax basis. Some of them also have other income like pension, consultancy fees, rent etc because of which, the interest they earn from FDs gets taxed at 30.90% and they end with around 6% post-tax return. This also results in them paying advance tax three times a year (September, December and March), since the bank deducts income tax on interest only at 10%. Many a times, such people are ill advised and end up giving declaration in form 15G/15H to the bank for non-deduction of income tax, resulting in payment of interest under section 234B and 234C of the Income Tax Act at the time of filing tax returns, due to shortfall in the payment of advance tax.

A smarter way of planning a pension for your retirement years is to invest the lump sum amount in debt schemes of mutual funds and use 'Systematic Withdrawal Plan' (SWP) to receive a monthly pension. SWP is a facility under which every month, on a pre-specified date, a fixed pre-specified amount is withdrawn from the designated mutual fund scheme and credited to the investor's account.

A client of mine, Ashok (name changed) came to me in June 2013. He had retired in March 2012 and had Rs 1 crore in his bank account. He was advised by the bank to put this amount in fixed deposits at 9% with monthly interest payout. He was happy to receive Rs 67,500 per month (after 10% deduction on account of income tax) and upgraded his lifestyle. Besides this interest, he had income from rent, pension and consultancy.

When he sat down to file his income tax return last month, he realized that out of the Rs 67,500 that he was spending every month, Rs 17,500 belonged to the government on account of income tax, as a result he had to cough up approximately Rs 2 lakh in taxes and interest at the time of filing his returns. His colleague, who retired around the same time and thought himself to be smarter, split his investible amount across a few banks and didn't get even the 10% income tax deducted and instead submitted declaration under section 15G of the income tax act. This smarter colleague had to cough up around Rs 3 lakh in taxes and interest at the time of filing his returns.

Now on our advice, Ashok has not renewed the FD and has invested Rs 92.05 lakh in the growth option of a medium-term debt fund (with an exit load of 1% up to one year) which at 9% yearly returns should grow to Rs 1 crore in one year. The remaining Rs 7.95 lakh has been put in an ultra short-term fund (no exit load) in the dividend reinvestment option. From this ultra short term fund (here he could expect to earn around 6.50% tax free dividends), we lodged an SWP of Rs 75,000 per month for 11 months (August 2013 to June 2014) after which, the balance in the ultras short term fund would get exhausted. From July 2014, the withdrawal shall come from the medium term debt funds. Since the medium-term debt fund on an average delivers around 9% yearly return, which is broadly in line with the inflation index under the Income Tax Act, it results in zero taxable capital gains on the units sold for the SWP.

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