Dividend vs SWP??
While making investments in Mutual Fund for the purpose of getting regular returns, one is stumped with the choice of either taking Dividends or opting for Systematic Withdrawal Plan (SWP). With the introduction of Dividend Distribution Tax on equity oriented funds, the debate gets thrown open for equity oriented as well as debt oriented funds.
To objectively analyze the choice, one needs to first understand the structure of mutual funds and how does the returns from funds get distributed. Mutual Funds are pooled investment vehicle structured in the form of a trust. There is a sponsor who floats the fund and an asset manager who is given the responsibility for managing the fund in a regulated environment. Investors are people like you and me and the amount collected is invested based on the objective of the fund which could be equity assets, debt assets, liquid assets or a combination of these. There are external oversights such as board of trustees, regulator i.e. SEBI and auditors who ensure that the fund is managed as per the given mandate.
Obviously, the purpose of making investments in to get returns out of it. There are broadly 2 ways in which the investor is able to cash out returns on his investment.
- Dividends – Which are returns triggered by the fund managers out of the realized gains from the investments they made out of the collected pool. Typically, such dividends are more predictable in case of stable underlying asset class such as debt oriented securities and could get un-predictable in case of more risk oriented (non linear return) underlying assets class such as equity.
- Withdrawals / Redemptions – The investor can invest into a growth option and can redeem the units which can either be a fixed amount or the appreciation in the value represented by the growth in Net Asset Value (NAV). Withdrawal / Redemptions are typically triggered by the investor and hence he is more in control of the amount and interval. Fund houses offer an option of systematic withdrawal whereby the investor can instruct the fund house to effect automated withdrawal of a fixed amount or the appreciated value at given intervals.
The tax treatments for the above options are very different and hence become the key decision factor between the 2 options.
Let us first have a look at the Debt Oriented funds and the tax treatment between dividend and systematic withdrawal assuming one is able to get the same amount credited into ones account. The dividends attract a dividend distribution tax (DDT) of 25%+ 12% surcharge + 4% Cess (29.12%) while in case of withdrawal, it will be subject to short term capital gains (STCG) tax of 30% +12% surcharge + 4% Cess (34.944%) in case of withdrawals less than 3 years and long term capital gains (LTCG) tax with indexation benefit of 20% + 12% surcharge + 4% cess (23.296%) in case of withdrawals after completing 3 years of investment.
Taking a case of an investor wanting to invest Rs.100,000/- at a NAV of Rs.10 per unit and assuming a growth of 7% annualized in debt oriented fund. In case of dividend option the cash flow would look as follows :
|Dates Dividend Decl||NAV before Div||Div per unit||NAV after Dividend||Div before DDT||*DDT (29.12%)||Div After DDT|
Now if the same investor is seeking to get similar cashflow as in case of dividend option and opts for systematic withdrawal plan. Keeping everything the same, the cash flow for this option would be :
|Dates of SWP||Amount of SWP||Unit Price||Units Available||Units Redeemed for SWP||Purchase price of SWP Units||Short Term Capital Gains||Tax on STCG @ 34.944%||Net to Investor after STCG|
You will notice that the investor in case of SWP has got higher payout as compared to dividend option and also his net value of investment in case of SWP after the 6 month period is higher i.e. Rs.101,012.67 (9754.83 x 10.3551) vis a vis the dividend option which stands at Rs.100,000/-. Obviously when the investment period crosses 3 years, the rate of capital gains tax will reduce and the gain to the investor will be much higher.
We can now use the same logic to verify the case of equity oriented fund (assuming a expected return of 10% annualized) where the result of choosing dividend and growth is given below respectively
Dividend Option :
|Dates Dividend Decl||NAV before Div||Div per unit||NAV after Dividend||Div before DDT||*DDT (11.648%)||Div After DDT|
SWP Option :
|Dates of SWP||Amount of SWP||Unit Price||Units Available||Units Redeemed for SWP||Purchase price of SWP Units||Short Term Capital Gains||Tax on STCG @ 17.472%||Net to Investor after STCG|
As in the case of debt oriented fund, in equity funds as well the tax arbitrage leaves the investor with higher amount vis a vis dividend option and on completion of 1 year, the capital gains tax would reduce to 10% + surcharge and cess. Hence, clearly the Systematic Withdrawal Plan works out far more tax efficient way of taking out returns at regular interval as compared to dividend option. Further more, in case of SWP, the control on the amount is with the investor unlike dividend option where the control is in the hands of the fund house.
Disclaimer : Mutual fund investment is subject to market risk. Please read the scheme related information and other related documents before investing. The example discussed in the article does not pertain to any fund in particular and for the sake of simplicity, the returns have been taken to be linear. In reality, the returns may vary month to month. The example is only for the purpose of demonstrating tax arbitrage between dividend and systematic withdrawal option. Please speak to your investment advisor to get a complete financial plan and accordingly your portfolio allocation.