In the last post we looked at an investment plan that will enable you to reach your desired state of financial independence at the chosen time. As we are going to depend on passive income for the intervening years between achievement of FI and formal retirement, it will be important to set up a passive income stream for this period.
It is important to reiterate that passive income happens out of actions or investments that you have undertaken earlier. Examples can be rent, dividends, interest, capital gains etc. Reorganizing your assets such as sale of property or trading income from the stock markets cannot be termed as passive income. There is nothing wrong with these or indeed in earning other regular forms of Active income. It is just that to be truly in a state of FI your need for Active income should be absent. So any active income you are earning can cater to further investment or any indulgences that were not planned for otherwise.
To set up a passive income stream you will need to keep two things in mind. Firstly, the income must be there with a high degree of certainty as you will depend on it. Secondly, as far as practicable you must try and reduce the tax incidence on this income. Obviously the more tax you pay, the higher passive income you will need and the longer time will be required for getting to the state of FI. With these conditions in mind you will need to start setting up a passive income stream at least 3 years before your chosen date for FI.
Your choice of passive income will very much depend on what you are comfortable with. I will therefore not attempt to give any prescription here, but suggest some options that you can consider. In an earlier post, I have already shared the passive income stream that I have set up for myself and you can take some pointers from there too.
- You’ll be getting some dividends from your stock portfolio. Estimate this accurately by averaging the dividends earned from your portfolio over the last few years.
- The above will be true for Equity Mutual Funds with Dividend option too, but most of you would have chosen the growth option. Redemption of MF is really a strategy to be used in Retirement so do not consider it here.
- Rental income from any property that you may own.
- Dividend income from Debt Mutual Funds if applicable.
- Capital gains from FMP redemption. Say you have 30 lacs in FMP and 10 lacs mature after 3 years of holding every year. On an average you will get LTCG of at least 2.4 lacs a year which will be tax free. If you are not comfortable with FMP you can set up the same mechanism with other debt funds. I prefer FMP due to certainty of interest rate.
- Withdrawal of monet from your PPF account.
- Interest earned from FD, POMIS, NSC, KVP etc.
You need to set up the passive income stream so that all your planned expenditure can be met through these for the years till retirement. Success in doing this without any worries will signify true Financial Independence.