When you invest your money, you hope to get some back in the future. This could be in the form of dividends from stocks, interest from bonds, rent from real estate, or profits from a business.
In mutual funds, you have two ways to get money back: through a systematic withdrawal plan (SWP) or through dividends, now known as Income Distribution Cum Withdrawal (IDCW).
Let us understand these options in simpler terms:
Systematic Withdrawal Plan (SWP)
With SWP, you can take out a fixed amount of money from your investment whenever you want. You get to choose how much and how often you want to withdraw. It’s good if you have a lot of money to invest and want a steady income without touching your main investment. The withdrawn money comes from selling some of your investment at its current value.
Dividend Plans (IDCW)
With IDCW, you get returns through both the growth of your investment and occasional dividend payments. These dividends are like bonuses from the mutual fund companies. Each time they declare a dividend, the value of your investment goes down a bit, but you get some cash.
Let’s Compare SWP and Dividend
Assured Income
SWP lets you decide how much and when you get money, while IDCW depends on when the fund company decides to give out dividends. So, SWP offers more certainty.
Flexibility
With SWP, you can adjust your withdrawals as your needs change. But with IDCW, you can’t control when or how much you get.
Returns
In SWP, how much money you get back depends on how well the market is doing when you take it out. With the Dividend Plan, the amount you get back relies on how well the mutual fund is doing overall.
Investment Goal
SWP is for those who need a fixed amount regularly, while IDCW is for those who want periodic cash from their investments, based on fund performance.
Predictability
SWP provides more predictable income, but IDCW depends on the fund’s performance for dividends.
Tax Impact
If you get dividends, they are taxed as regular income. But with SWP, you are taxed on the capital gains as you sell some of your investment. This can sometimes lead to lower taxes, when your marginal tax rate is high.
If you choose the dividend option of a mutual fund, the dividends you get are added to your taxable income and taxed based on how much you earn. If your total income, including dividends or capital gains, is below the minimum tax threshold (Rs. 3 lakh for senior citizens) and you don’t have other income, then there’s little distinction between the dividend option and SWP.
However, if you have additional sources of income, and you fall into the higher tax brackets of 20 to 30 percent. Opting for the dividend plan, whether it’s from an equity or non-equity fund, means the dividend adds to your total income, subject to a 30 percent tax if you’re in the highest tax bracket. For instance, if you receive Rs 1,000 as dividend income, Rs 300 would be your tax obligation.
If you choose a growth plan and later use SWP, taxes are based on the capital gains when you sell your units. For equity funds, taxation varies depending on how long you have held the units.
If you sell your units within a year, you will have to pay 15 percent tax. If you hold them for over a year, you will pay a 10 percent tax on gains exceeding Rs. 1 lakh.
Risk
The SWP is safer than the Dividend Plan because you can take out a set amount of money no matter how the market is doing. But with the Dividend Plan, what you get back depends on how well the mutual fund is doing, and that can be risky because it’s tied to the ups and downs of the market.
In short, SWP is better if you want predictable income and flexibility. It’s good for covering regular expenses. But if you are not relying on your investments for everyday needs and just want to enjoy profits, IDCW might suit you better.
Let’s understand better with the help of an example.
Why SWP Scores better over Dividend
Let’s say Aarya has Rs. 2 crore when she retires at 60. She puts it all into a liquid fund that gives about 5% annually. So, she gets around Rs. 10 lakhs per year or Rs. 83,333 per month. But that’s less than what Aarya wants, which is Rs. 1 lakh per month. Plus, when Aarya gets Rs. 83,333 each month, the fund takes away about 29.12% as tax which is DDT (Dividend Distribution Tax), leaving her with only Rs. 59,066. That’s way below what she needs. That’s when SWP steps in to help.
Now, if Aarya sets up an SWP with 5% returns, she can withdraw Rs. 16.05 lakhs per year or Rs. 1,33,750 per month. That’s a lot more comfortable for her to cover her expenses. The tax will be much lower too, only on the gains portion after 3 years. After spending her monthly Rs. 1 lakh, she will still have some money left, which she can invest. This corpus will last her until she’s 80. SWP surely makes a lot of sense for Aarya.
Investors must evaluate their individual financial goals and seek guidance from professional financial advisors to tailor income-generating strategies from mutual funds to their specific needs. Consulting with experts ensures personalized approaches for maximizing returns and meeting long-term financial objectives.
FAQs
1. How does a Systematic Withdrawal Plan (SWP) contribute to generating income from mutual funds?
Systematic Withdrawal Plan (SWP) allows investors to regularly withdraw a fixed amount from their mutual fund investments, providing a steady income stream while potentially minimizing taxes on capital gains.
2. Are there tax implications associated with opting for SWP or choosing dividends from mutual funds?
Yes, SWP taxation is based on capital gains upon selling units, with a 15% tax if sold within a year and 10% on gains over Rs 1 lakh held for over a year, while dividends from mutual funds are added to taxable income, taxed based on income slab. Taxes charged on dividends is called Dividend Distribution Tax (DDT).
3. What factors should investors consider when deciding between SWP and Dividend for income generation?
Investors should consider their tax bracket and other income sources to determine whether SWP or Dividend option is more tax-efficient, also assessing their liquidity needs and investment goals for consistent income flow.
4. What role does the investor’s financial goals and risk tolerance play in choosing between SWP and Dividend?
The investor’s financial goals decide if they need a regular income or want their money to grow over time, while their risk tolerance shows how comfortable they are with potential ups and downs. These factors help them choose between SWP for steady income or Dividend for periodic payouts.
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