Dividend vs SWP: Which withdrawal option is better for MF investors?

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February 10, 2020 6:33 PM

Some AMCs pay regular dividend on some MF schemes, so investors choose dividend payout option to get regular dividend income.

mutual fund, MF, equity MF, debt MF, dividend payout option, dividend distribution tax, DDT, dividend income, tax-free dividend, taxable dividend, TDS on dividend income, systematic withdrawal plan, SWP, capital gain tax, indexation benefitIn Budget 2020, Finance Minister Nirmala Sitharaman has scrapped the DDT, but has made dividend taxable.

While investing in mutual fund (MF), an investor gets two basic options – growth and dividend to choose. Under the dividend option, two sub options are there – dividend add back and dividend payout. Under the growth option, the entire capital invested grows with time in a fluctuating manner as per the movements in stock markets. While, dividend add back option is quite similar to growth option, under dividend payout option, Asset Management Companies (AMCs) pay dividends to investors, when they have distributable profits in a particular MF scheme.

Some AMCs pay regular dividend on some MF schemes, so investors choose dividend payout option to get regular dividend income. However, in the case of regular dividend, there may be risk of decline in capital invested, if dividend is distributed in a low market without distributable profit.

The growth and dividend options are available in both equity and debt funds. Chances of capital loss under dividend payout option is less in case of debt funds as they are less volatile in comparison to equity funds. However, so far the dividend distribution tax (DDT) on debt funds were more than equity funds, which was a dampener.

Despite such drawbacks, many investors used to choose the dividend payout option to get regular income, as dividend was tax-free in the hands of the investors.

In Budget 2020, Finance Minister Nirmala Sitharaman has scrapped the DDT, but has made dividend taxable. Unlike DDT, the new tax rule makes dividend more taxable for people with higher income than the people in lower income group.

To avoid higher tax outgo, it is advised that instead of dividend payout option, it will be better for investors to choose growth option.

To get regular income under the growth option, an investor may put systematic withdrawal plan (SWP) in place. Like systematic investment plan (SIP), which is used for regular monthly investments, especially in equity funds, SWP is a system of regular withdrawal, under which, you may select a day in a month, on which you would receive the redemption proceeds.

To avoid eating up of capital, an investor should opt for lower SWP so that withdrawals are made out of the growth part and the capital invested stays protected.

The benefit of SWP over dividend is that capital gain tax is levied on SWP, while dividend income attracts income tax.

For example, in the case of dividend income of Rs 6 lakh in a financial year, under the new tax regime, an investor in highest tax bracket has to pay up to 30 per cent tax, while in the case of SWP, an equity MF investor has to pay 10 per cent tax and that too only on gain part over Rs 1 lakh in a financial year.

Debt fund investors need to pay 20 per cent tax on long-term capital gain (LTCG) after indexation, which is very low.

So, SWP is a better option than dividend payout, as you would end up paying less tax and having more control to protect their capital invested.

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