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Guest Column SWP or dividends, what should you recommend to your clients?

SWP or dividends, what should you recommend to your clients?

SWPs are more tax efficient as these are treated as growth plan of mutual funds for tax purposes.
Karan Datta Jun 11, 2018

When your clients are looking to generate regular cash flow from mutual funds, they often find it difficult to decide whether or not they should redeem their investments. Currently, mutual fund investors have two options to generate regular cash flow, systematic withdrawal plan (SWP) or dividends. Let us understand what is best suited for your clients.

Dividends in mutual funds

Choosing the dividend option for a mutual fund scheme entitles an investor to receive dividends declared by the fund scheme periodically. Dividends are tax-free for investors. The fund house though has to pay Dividend Distribution Tax (DDT) on such dividends on behalf of investors. This means investors indirectly bear the tax burden on dividend income.

However, in case of close-ended schemes or schemes with a lock-in period like ELSS, the dividend option is preferable. This is because your clients will receive part of the profits throughout the investment tenure. Even though the investment is locked in, they would still benefit from some liquidity from time to time. 

Systematic Withdrawal Plan (SWP)

Just as systematic investment plans (SIPs) allow investors to make investments in mutual funds periodically, SWPs redeem your investments periodically. SWPs give investors the flexibility to choose the periodicity and amount of redemption.

Why SWPs score over dividends

Here are three reasons why an SWP is a better option than dividends

  1. Consistent cash flow: The dividend option does not guarantee regular cash flow since AMCs declare dividends after realising profits, if any. However, with SWPs, your clients can choose to have regular cash flow by redeeming their investments. There is no ambiguity on cash flow with SWPs.
  2. Control over quantum of cash flow: With SWPs, your clients can decide the amount and timing of cash flow depending on requirement. Simply put, your clients cannot rely on the dividend option to meet regular requirements.
  3. Tax efficient: The government levies DDT on dividends arising out of mutual fund investments. Since the NAV of the fund is reduced to the extent of dividend, investors end up paying the tax from their MF investments. SWPs, on the other hand, are treated as redemption from mutual funds. The tax treatment of such redemption is just like growth options in mutual funds.

Hence, SWP scores over the dividend option. However, if the periodic payouts are considerably higher than the returns generated by the mutual fund, you should consider recommending the dividend option as the investment amount might get exhausted. There is no such fear with the dividend option, as any dividend has to be declared only out of profits realised.

Karan Datta is the Chief Business Officer at Axis Mutual Fund. The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.

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Pramod puranik · 9 months ago
I am strong believer of divi distribution each and every mutual fund should earn more distribute more and then only they will get more
Regarding SWP short term capital calculation is must for first year it is not required in divi distribution
Thirdly divi yield veries from person to person depending on period of his investments purchase NAV and profit booking my clients when they already got back their capital they have very good divi yield so you can not generalise pl note that we have enjoyed tax free divi since 1997 in equity and since 2001 in mutual funds so if there is only 10 percent divi distribution tax no body should complain complain about it
Sanjay Shah · 9 months ago
If investor is in higher tax bracket of more than 10% than tax-free divided is a welcome option and is free of all short and long-term capital gain calculation. Such investor also have higher chance of having long-term capital gains from direct investment in stock which is limited to 1 lakh only tax-free.
VINOD SHIRALKAR · 9 months ago
SWPs redeem your investments periodically. SWPs give investors the flexibility to choose the periodicity and amount of redemption. They are tax efficient too however they are better for a rising market.
In a bearish market, they may be disastrous.
For a client who needs a lower sum equal to one lakh, they are tax-free even but for a higher need of cash flow Dividends are still good.
Ravikumar · 9 months ago
In SWP, How and where to find weather SWP amount is Redaming part of Principle or Growth , as for redemption is concern First cum first units, let us assume if one invested 10 lakhs , and SWP of 8k pm, most of the SWP happen part of Principle. Then how to Calculate Long term capital gain tax.
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