Investors typically invest their money with the expectation of generating returns in the form of cash flows in future. These cash flows can take many different forms, such as dividends from stocks, interest payments from bonds, rental income from real estate, or profits from a business venture.
In case of investing in mutual funds, the cash flows could be of two types: Systematic withdrawal plan or dividend payout option. Dividend payout option is now called Income Distribution Cum Withdrawal (IDCW).
In this article, we are going to discuss the options available to investors in planning their regular cash flows from mutual fund investments.
Systematic withdrawal plans (SWP) and dividend plans are two popular investment options in India. Both these plans offer regular income to investors.
SWP is a facility offered by mutual funds where an investor can withdraw a fixed amount of money at desired intervals from the investment. The investor can choose the amount and frequency of withdrawal according to their financial needs.
It is suitable for investors who have an existing large portfolio or lump sum amount to invest and are looking for regular income without affecting the principal amount. In an SWP, the amount of withdrawal is generated by redeeming the units of the scheme at current market price as on the date of withdrawal. The SWP option is typically used with the growth option in mutual funds.
Dividend plans (IDCW) of mutual funds provide returns through capital appreciation and dividend payouts. As per these plans, the dividends are typically declared by the fund houses on a regular basis.
The net asset value (NAV) of these plans is lowered by the dividend amount. The main difference between the two is that in dividend plans, units are not redeemed if the NAV is lowered by the amount distributed as dividend.
Let us compare both these plans on basis of various factors:
Assured flow of income: SWP is designed in a manner where investors can decide the amount of money along with the frequency of payouts. The units are redeemed as per defined frequency to generate the amount fixed by the investor. In the case of dividend option, the amount as well as the frequency is determined by the asset management company. They may or may not choose to pay dividends based on the profits generated on the portfolio. Hence regular cash flow is not assured.
Flexibility of inflows: In the case of SWP, cash flows can be altered based on changes in the needs of an investor. An investor can increase or decrease the amount of withdrawals along with the frequency of withdrawals. All these alterations are in the control of investors. In the case of a dividend plan, none of the above factors are in control of the investor.
Investment objective: SWP is designed for investors who want to withdraw a fixed amount of money periodically from their investment irrespective of the performance of the investment. Dividend plan is for investors who want regular income in the form of dividends that will be declared by the asset management companies based on their assessment of distributable profits.
Predictability: SWP is highly predictable as investors will keep getting cash flows regardless of market conditions. Dividend plan may or may not declare the dividend if the performance of the scheme does not justify a dividend.
Taxation impact: This is the most important factor in determining the option to be used by an investor. In case of the dividend option of a mutual fund, the dividends you receive are added to your taxable income and taxed as per your slab. However, if you opt for a growth plan and then go for an SWP, the tax is calculated on the capital gains when you redeem the units. Capital gains tax depends on the holding period and type of mutual fund they have invested in. The extent of capital gains tax depends on the number of units being redeemed.
In conclusion, a systematic withdrawal plan is a better option in terms of predictability of returns & the flexibility of changing the factors withdrawal amount or frequency of withdrawal. Also, the tax incidence on systematic withdrawal plans is lower if an investor falls in higher tax slab rates.
SWP option should be used by individuals who are dependent upon the investment corpus for their day to day needs and basic lifestyle necessities as in this case, the expenses are fixed in nature and the investor needs a defined inflow to take off the expenses.
However, if an investor wants to purely enjoy the withdrawal of profits & is not dependent on the investment for his day-to-day necessities then dividend option might make more sense. It is suggested to take assistance of an advisor who can assess the parameters on an individual basis and make suggestions regarding the option to proceed with.
Rohit Gyanchandani is Managing Director at Nandi Nivesh Private Limited