Mutual funds offer a variety of smart and convenient options to meet specific needs of investors. Many investors want regular income from their mutual fund investment – similar to receiving a salary.
In this article, we explore why SWP (Systematic Withdrawal Plan) is a better option when compared to a dividend plan.
In this article
What is a Dividend Plan?
Dividend mutual funds are funds where dividends are given to investors at intervals by the mutual fund company. These funds are just like growth funds, except one difference.
In case of growth funds, the earned amount gets reinvested by the mutual fund company whereas in case of dividend funds the amount is paid back to the investors at intervals.
A mutual fund scheme declares dividends from its realized gains.
Realized gains are the profits made by the fund manager by selling shares. Schemes can decide the frequency of the dividend payments (daily, monthly, quarterly, annually).
What is a Systematic Withdrawal Plan (SWP)?
An alternative to investing in dividend fund is to invest in Systematic Withdrawal Plan (SWP). In this, a fixed amount can be withdrawal at fixed intervals. Moreover, the frequency and amount of withdrawal can also be selected by the investor.
For example, if an investor has invested ₹ 50,000 in a scheme, he can set up an SWP to withdraw ₹ 5,000 every month on a specific date for 10 months.
There are no specific funds that are considered as being good or bad for SWP. This method of redeeming your money, from a fund, can be employed depending on the need for cash of the investor.
4 Reasons Why SWP Is Better Than Dividend Plan
In general, SWP scores over Dividend plan on most fronts. Here is the list of 4 reasons, why SWP is a better option than Dividend plan:
1. Surety of Fixed payout
A Systematic Withdrawal Plan (SWP) entails a stable payout to the investors at predetermined intervals. This implies that at some stage the investments will be completely repaid along with the gains.
Going for the dividend plan would mean that your monthly income would be subject to the dividend declared by the scheme you have chosen to invest in.
Though there are few funds, which have given good returns on a consistent basis but the dividends for most of the funds have not been very consistent.
So, an investor is assured of getting a fixed amount at his/her pre-determined frequency through an SWP.
However, the payout is not certain in a dividend plan. Dividend payments are neither fixed, nor guaranteed. If there are no realized gains made by the fund house, there will be no dividends at the end of the month.
Dividend distribution tax (DDT)
The dividend paid by mutual funds is not taxed in the hand of investors, but a dividend distribution tax (DDT) has to be paid by the mutual fund company.
Apart from money market and liquid funds, a DDT of more than 12.5 % is deducted from dividend coming from debt funds. Whereas, in SWP, there is no dividend or any DDT thereof.
DDT imposed by the government on dividend payments made by the equity oriented mutual fund schemes is the primary reason for SWP’s popularity.
Investors of the dividend option of balanced funds have become habituated to monthly dividends due to a controversial practice started by some mutual fund houses to declare dividends every month.
Long-Term Capital Gains (LTCG)
SWP is more tax efficient as ₹1 lakh of LTCG is tax exempt, while dividends are taxed at a flat rate of 10%.
Also, a investor of small sum, may be able to avoid tax on his gains, if the LTCG accrued on the amount withdrawn under the SWP remains below the ₹ 1 lakh threshold.
In case of an SWP when you opt for a growth plan in the initial years of an SWP, the gain portion is much smaller. Most of the payout actually consists of the principal amount of investment.
Hence, after the government introduced the Long Term Capital Gains (LTCG) tax on equity investments for gains over ₹ 1 lakh p.a., the dividend option has become unappealing to many investors.
3. Avoid Market Risk
SWP helps to avoid the trap of market timing at the time of redeeming the equity mutual fund units: Just as systematic investment plans (SIP) avoid market risk at the time of investment, SWPs lower market risk at the time of redemption.
4. Financial Independence for Your Family Members
In life, however, there are times your family members require your financial assistance to address their contingencies. In such a case, giving money in lump-sum isn’t the most helpful approach. Your loved ones might need your help for an extended period of time.
Under such circumstances, you can think of dedicating an SWP to a family member in need. Mutual fund houses have started offering you unique options to transfer money to your family members.
SWP facilitates you to withdraw a fixed sum of money from a mutual fund scheme regularly (say monthly, quarterly, half-yearly and annually) and hold the potential to clock returns on the remaining investments over a period of time.
Recently, the SBI Mutual Fund launched Bandhan SWP—a unique facility that allows you to systematically withdraw money from your investments with the fund house and transfer it directly to the account of a beneficiary.
Bandhan SWP defines the relationship between a ‘Responsible Giver’ (Investor) and a ‘Confident Receiver’ (Beneficiary). It facilitates a regular payout which the beneficiary can use for monthly sustenance, additional financial support, lifestyle maintenance or recurring expenses.
In general, SWP scores over dividend strategy on most fronts. However, SWP works better when a person has invested and accumulated a significant sum (with respect to the withdrawal one is seeking). In a small investment, if the return generated is less than the regular payouts, it will fast erode capital.
Monthly Income Plan works out to be the best option for investors in need of regular flow of income. However, dividend option of monthly income plan doesn’t always guarantee regular stream of income. So, it is advisable to choose SWP option over dividend option.
To look at some of the best performing funds from every category of mutual funds, check out Groww 30 best mutual funds to invest in 2018.
Disclaimer: the views expressed here are of the author and do not reflect those of Groww.