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One of our readers wrote to us with this query:
There is no indexation benefit in debt funds. It is taxed at the marginal rate of taxation now. Considering this, should I recommend Income Distribution of Capital Withdrawal (IDCW) option (dividend option) in a fixed income fund to a retired client for generating regular income? If both growth and dividend option have similar taxation in debt funds, what’s the point of setting up SWP in debt funds? Also, I find dividend option simpler for investors?
Name withheld on request
Dear Reader,
Thanks for writing to us.
Ideally, you should refrain from recommending Income Distribution of Capital Withdrawal (IDCW) option or dividend option for generating regular income.
Instead, setting up SWP in debt funds makes a lot of sense for investors seeking regular income.
While taxation of fixed income fund is similar for dividend option and growth option i.e. investors can no longer get benefits of indexation and are taxed at their tax slabs, only capital gains are considered for taxation in SWP as against the entire dividend amount in the IDCW option.
Simply put, the entire dividend income is added to your income and then taxed accordingly. Further, dividend income is subject to TDS at the rate of 10% of the total dividend pay-out for Indian investors and 20% of the total dividend payment or NRIs.
SWP, on the hand, is treated like redemption where you sell MF units. It is more tax efficient as only capital gains arising out of redemption through SWP are taxable.
Let’s understand this with another illustration. Your client opted for yearly SWP of Rs.7 lakh. Of the total Rs.7 lakh, assume that Rs.4 lakh is principal amount and Rs.3 lakh is the capital gains. The capital gains of Rs.3 lakh will be added to the annual income of your client for taxation.
Now, if your client is above 60 and does not have any other source of income, he need not pay any tax on these gains as senior citizens having annual income of up to of Rs.3 lakh are exempted from paying any tax. In a way, your client can use entire Rs.7 lakh without paying a single penny in tax.
However, dividend income is taxable from Re.1. In the above case, your client would pay Rs.50,000 as tax if he opted for IDCW option.
Further, SWP in equity funds or aggressive hybrid funds are more tax efficient as your clients need to pay a flat 10% tax on gains exceeding Rs.1 lakh after 12 months.
And if your clients redeem within a year, they will have to pay 15% on the total gains as tax.
Hope, we have addressed your query.
Regards,
Team Cafemutual
