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Mutual fund investments can come with different withdrawal plans. While many people may like to withdraw money in lump sum amounts as and when required, others would like to get a regular income from their mutual fund schemes.There are two ways of generating regular cash flow from a mutual fund without exiting the scheme completely- The dividend option and the systematic withdrawal plan (SWP). Investors should carefully weigh the benefits of dividend vs SWP plans before deciding which one to purchase.
Understanding the Dividend Plan in Mutual Funds
When a company or a firm makes a profit, it can have surplus cash. The company can use this surplus amount in two ways- either reinvest the money in the business for growth and expansion or distribute the profit amount between its shareholders. The distribution of profit by the company among its shareholders is called dividend payout.The same goes true for mutual funds.Mutual funds can be of two types- growth plan and dividend plan. The growth plans don’t pay any dividends. Instead, they reinvest the profit back into the scheme, intending to provide high returns to unitholders on redeeming the units while closing the mutual fund account.On the other hand, dividend plans aim to provide regular dividends by distributing a portion of the profit among the unitholders. The fund manager decides the dividend amount to be given by the mutual fund.The fund manager can also choose to hold on to the surplus cash reserve to enable regular dividend distribution in adverse market conditions in future.It should be noted that a fund house can pay dividends only from the realised profit, which is the profit that is converted into cash. Therefore, you might not get dividends solely on the basis of the increased value of your mutual fund units if there is no realised profit.
Understanding the Systematic Withdrawal Plan
A systematic withdrawal plan or SWP enables the mutual fund unitholders to redeem their units periodically. Here, investors can provide a mandate to the fund house about the frequency of withdrawal such as monthly, quarterly, or annually as per their choice.Once the mandate is set, the amount will be automatically sent to your bank account.SWP operations are similar (or rather opposite) to SIPs. In SIPs, the amount is automatically debited at a fixed interval from your bank account and is used to buy mutual fund units. In contrast, in SWPs, mutual fund units are redeemed at a fixed interval, and the amount is credited to your bank account.
Comparison- Dividend Vs SWP
Comparing dividend vs SWP against a set of common parameters can help get a clearer perspective about which withdrawal plan is better suited for your needs.
| Parameters | Dividend Fund | SWP |
| Portfolio Size | You earn money from dividends without redeeming your units. Therefore, the portfolio size is unaffected as the number of units remains the same during the entire investment period. | You earn money by periodically redeeming your mutual fund units. Thus, your investment portfolio reduces in size with every withdrawal. |
| Net Asset Value | NAV is lowered as the profit is not reinvested in the fund. | The withdrawals don’t affect the NAV. |
| Withdrawal Amount | Since the dividend is subjected to profit, such funds can never guarantee the amount of withdrawal. | The withdrawal amount depends on the unitholder. The unitholder can withdraw a fixed amount at regular intervals as long as there are funds to redeem in the unitholder’s mutual fund. |
| Controlling the Cash Flow | Investors can’t regulate their dividend income. Once a mutual fund house announces the dividend, all its unitholders will receive the money in their account whether they want it or not. | The SWP is under the complete control of the investor. The investor can start or stop the SWP as and when needed. The investor can also increase or decrease the amount of SWP. |
| Taxes | Earlier, dividends were tax-free in the hands of the investors. However, the government of India made amendments to the rules applicable from the financial year 2020-21. As per the new rules, the dividend income of investors is added to their taxable income and taxed as per the respective income tax slabs. |
Since investors are redeeming their mutual fund units, long or short term capital gains tax is applicable depending on the holding period and type of mutual fund.
Long-term capital gains tax:
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Which Is a Better Withdrawal Option?
You can consider the following simplified guidelines to determine the withdrawal plan best suited for you.
Choose SWP If
- You need a regular income source as a pension amount.
- Your annual income falls in a higher tax slab. You might end up paying a significant amount of income tax over your dividend income if you have a high income.
Try to keep your SWP amount low so your capital remains protected and gets ample opportunity to grow further.
Choose Dividend Plan If
- You are not worried about getting a fixed, regular income.
- You want payouts without diluting your units in your fund scheme.
- You fall in the low tax brackets, and your tax liability on dividends earnings is low.
Both dividend and SWP have their own set of advantages and disadvantages. Therefore, you need to choose carefully after weighing your options based on the facts discussed here.
DISCLAIMER
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
