Systematic Withdrawal Plan v/s Dividend Option in Mutual Funds
While it is essential to invest and make your money work harder, it is equally crucial to reap the benefits of such investments to enjoy the wealth and use such investments to fulfil pending financial goals and dreams. For example, when one retires, they may rely on the retirement corpus accumulated during the working life to spend the rest of their lives. While one may make a lump sum redemption and cash out all the investments in one go, one should withdraw the amounts on a periodical basis. The investors may either opt for dividend plans in the mutual funds or register a Systematic Withdrawal Plan to achieve the objective of making periodic withdrawals.
Fundamentally, both these options differ from each other in terms of the flexibility, and certainty they offer to the investors. However, before we discuss such differences, let us first know what each of these options denotes.
What is Systematic Withdrawal Plan (SWP)?
It is an option provided by the mutual funds to the investors, wherein they may opt to periodically redeem their investments and receive the redemption proceeds in the bank account. Like one may make periodic investments through SIP, an SWP enables the investors to do precisely the opposite with SWP.
Dividend Plans in Mutual Funds
The mutual funds are generally offered under two plans – Growth plan and Dividend plan. While the investors may earn returns through capital appreciation in growth plans, dividend plans offer returns through dividends as well as capital appreciation. Dividend in such plans is generally declared by the mutual fund houses on a periodic basis, wherein the NAV of the fund is reduced by the dividend amount along with the dividend distribution tax amount.
SWP vs. Dividend :
Here is a comparative analysis of SWP and Dividend options:
1.Impact on Portfolio Valuation :
The dividend option reduces the NAV of units to the extent of dividends declared along with related taxes, while the number of units remains the same. On the other hand, SWP reduces the number of units while keeping the NAV same. As such, both strategies result in lower portfolio valuation.
2. Controlling the Cash Flow :
When one makes investments in dividend plans, the dividends may be received by the investors even when they may not want such cash flows and, instead, may like such cash flows to be reinvested in mutual funds during the wealth creation phase. On the other hand, one may register an SWP as and when the need for periodical cash flows arise with the investor. As such, SWP enables investors to manage their investments realistically.
3. The certainty of The Quantum of cash flow :
Dividend may be declared by the fund house only out of the realized profits. As such, the dividend as may be declared by the fund house may not be entirely predictable. On the other hand, SWP provides a sense of certainty to the investors in terms of regular cash flows, as the investor needs to specify such withdrawal amount at the time of the registration of SWP, depending based on monthly expenses, other needs as well as the fund corpus available.
4. Tax Efficiency :
The fund house is liable to pay Dividend Distribution Tax (DDT) on mutual funds at 10% (plus applicable surcharge and cess) on equity funds and 25% (plus applicable surcharge and cess) on other funds, e.g. debt funds, etc. While the dividend is considered as tax-exempt for the investors under the Income Tax law, the impact of such DDT is borne by the investors only as the tax is paid out of the scheme assets itself, thereby reducing the NAV to that extent. As such, the investors need to bear a fixed DDT percentage on such dividend payouts, irrespective of the tax rate applicable to the investors. On the other hand, when one redeems the investments through SWP, the tax rates as applicable to the investor will be applicable. As such, the investors may be able to avail of lower rates of 10%/ 15%/ 20% or the slab rates depending upon the type of funds as well as the holding period of such mutual funds.
5. Availing the LTCG Tax Exemption Limit :
The tax laws provide for an annual exemption up to Rs. 1 lakh in respect of long-term capital gains from equity shares and equity-oriented mutual funds. As such, SWP may enable the investors to plan their withdrawals in such a manner so that they may avail the maximum amount of this annual exemption available every year.
Considering the superiority of SWP as a systematic approach to utilize the investment corpus in a systematic and planned manner, the investors may consider fulfilling their cash flow requirements through SWP.
Note: The tax benefits as mentioned in the article are updated for the latest Union Budget presented, i.e. Finance (No. 2) Act, 2019. However, the tax treatment will be as applicable on the redemption date.