BackGet SWP on your debt fund for better returns
A systematic withdrawal plan is more tax efficient than the dividend option of a debt mutual fund, and this helps boost your post-tax returnsSWP withdrawals are not dependent on the fund’s performance
PremiumA common question clients ask financial planners regarding a debt mutual fund investment is whether they should opt for the dividend option or withdraw regularly through a systematic withdrawal plan (SWP). Planners weigh in for SWP as the dividend option results in a higher tax outgo for investors across tax brackets, reducing the overall returns.
“Many investors get lured by the dividend option because they are told that they don’t need to pay tax on the money received, which is true. But the company deducts dividend distribution tax (DDT) before distributing the funds," said Suresh Sadagopan, founder, Ladder7 Financial Advisories, a Mumbai-based financial planning firm. We tell you how an SWP is better than the dividend option in terms of taxation and other issues.
Tax benefits of SWPs
When you collect dividends from your debt mutual fund, the fund house pays a DDT of 29.12%, including cess and surcharge, on your behalf on the entire gains realized and distributed as dividends. In comparison, the tax you would pay on withdrawals through SWP is much lower. There are two reasons why. One, your withdrawal from SWP has the principal as well as the gains components, and tax is charged only on the gains. Even when you pay tax on the gains, the rate is much lower in most cases.
If you withdraw from a debt fund within three years of investment, the gains are added to your income and taxed based on the applicable slab rates. If you withdraw after three years of investment, the gains are then taxable at 20% after indexation. Remember that the tax liability reduces significantly if withdrawals are made after 36 months due to the indexation benefit.
If you are in the tax bracket in which you don’t have any tax liability and do not have substantial gains, there may be no tax payable on short-term capital gains in case of an SWP. On the other hand, funds would deduct the applicable tax, irrespective of the tax slab or liability.
Also, in case you make a loss, you can save taxes by adjusting your gains against it. Tax regulations allow taxpayers to set off short-term capital loss against short-term as well as long-term capital gains. Long-term capital loss can be set off only against long-term gains, and can be carried forward for eight years.
Other benefits
Customization: Typically, it’s the retirees who need a regular cash flow from the corpus they would have accumulated during their working life. Sometimes, even individuals going on a sabbatical need a fixed amount at regular intervals. An SWP scores over a dividend option on that count. “Systematic withdrawals can be customized based on the requirement. Dividend distribution, however, is not fixed," said Deepesh Raghaw, a Sebi-registered investment adviser.
Freedom to withdraw: SWP withdrawals are not dependent on the fund’s performance. On the other hand, mutual funds distribute dividends from a surplus in realized gains accumulated in a fund.
So the dividend option may not serve the purpose of drawing a regular income. A fund house may have a track record of paying dividends regularly, but it doesn’t have an obligation to do so. There could be a period when the fund is not doing well, and the fund manager may choose not to pay dividends. The amount paid could also vary depending on the surplus available.
Remember not to confuse dividends distributed by mutual funds with the dividends companies announce for their equity investors. Mutual funds pay dividends out of the gains accrued. Once the dividend is paid by a fund, the net asset value (NAV) or the value of units falls by that extent.
Exit loads
The only hindrance in SWP is the exit load that mutual funds charge.
This depends upon the type of debt fund and reflects the minimum holding period suitable for a fund. Ideally, you should consider withdrawing from the fund only after this period is over.
In some categories of short-tenor funds, such as liquid and ultra short-term, fund houses usually don’t levy an exit load after a few months of investment. You also have the option to choose a scheme with a track record that does not charge an exit load.
MINT Take
Systematically withdrawing from a debt scheme gives investors higher post-tax returns and more flexibility to meet their cash flow requirement vis-a-vis the dividend payout option.
In the dividend option, there is no predictability of the amount that would be paid out and it also attracts higher tax. If you have opted for the dividend option, shift to an SWP with a growth option.
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