Here we evaluate both the options and tell you which should you pick for your income needs
09-Sep-2022
One of the questions which we frequently get is whether retirees should invest in the 'dividend' plan of a mutual fund scheme for deriving regular income. In mutual funds, there are two ways of generating cash flow for deriving income - the dividend option and the systematic withdrawal plan (SWP).
While many consider the dividend option, there are a few caveats that you must know about. We've listed three such points that you should understand before you make a decision.
1. Guaranteed flow of income
Many people go for a dividend plan thinking that they will receive dividends every month or at a fixed interval. But it is not really guaranteed that a mutual fund scheme will continue to pay dividends regularly in the future even if it has a history of doing so. The fund can be a dividend-paying fund, but the timing and amount are at the discretion of the fund house. So the frequency and the quantum of dividends are not guaranteed.
In that way, if someone is looking to derive a regular source of income for their living expenses, then a systematic withdrawal plan (SWP) would be a better option. With SWPs, once you give a standing instruction, you receive a predefined amount of money in your bank account every month at the chosen date.
For example, you can instruct the fund house to pay you Rs 50,000 every 5th day of the month. This instruction will guarantee a steady flow of income for your regular expenses.
Now, which are the funds that you can invest in for your regular income? Find out the suggested investments for you. These will help you earn dependable income from your investments, better than the traditional options.
2. Flexibility
Building on top of the previous point, the investor has no flexibility since the amount of dividend and the frequency of payout in case of the dividend plan is at the discretion of the fund house. It is possible that the investor might need a higher amount of money every month over the next year (maybe because of some medical condition or inflation). In such a case, it won't be possible in case of a dividend plan unless the investor manually makes a redemption request.
However, if one chooses a growth plan and then plans for an SWP, one can define the amount and frequency of withdrawal. In such a case, one can simply instruct the fund house to credit a higher amount every month continuously for a year. Also, this would be on auto-pilot.
Suppose you were withdrawing Rs 50,000 per month, but after a year you wish to increase that to Rs 70,000 per month. You can do it easily with SWPs. However, you don't have this flexibility with the dividend plan of a mutual fund.
3. Taxation
If you opt for the dividend option of a mutual fund, the dividends you receive are added to your taxable income and taxed as per your slab. If you don't have any other income and your total income including dividends or capital gains is less than the minimum threshold for tax liability (Rs 3 lakh in case of a senior citizen), then there's not much difference between the dividend option and SWP.
However, there will be a difference if you have other income sources and you come under the higher tax bracket of 20 to 30 per cent. If you choose the dividend plan, irrespective of whether it's an equity fund or a non-equity fund, the dividend gets added to your income. This income will draw a 30 per cent tax on it if you are on the highest tax slab. For example, if you receive Rs 1,000 as dividend income, Rs 300 will be the tax liability.
In case you opt for a growth plan and then go for an SWP, the tax is calculated on the capital gains when you redeem the units. If you've invested in an equity fund, there are two scenarios for taxation which depend on your holding period.
Certainly in both scenarios, it is less than 30 per cent that one would pay in case of a dividend option.
Likewise for a non-equity fund, if one sells the units after three years, the gains are taxed at 20 per cent after indexation. Indexation helps adjust your cost of investment to inflation and thereby reduces the taxable gains. However, if the units are redeemed within three years, the taxability would be at par with the dividend option.
This is the only scenario where the taxability in SWP is similar to the dividend option. But in the other three scenarios, the SWP scores as a better option.
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