SWP is better than Dividend Option in Mutual Funds

Mutual Funds: Everything You Wanted to Know About Them
December 24, 2019
SWP is better than Dividend Option in Mutual Funds
March 26, 2020

SWP is better than Dividend Option in Mutual Funds

If you have already invested in dividend payout option of mutual funds for getting a regular income? You should reconsider your investment since dividend option may not be attractive any more due to changes proposed in Budget 2020.

Presently, a 10% dividend distribution tax (DDT) is paid by equity oriented mutual funds and dividends are tax free in the hands of the investors. Budget 2020 (effective from April 1st, 2020) has abolished DDT and instead made dividends taxable in the hands of investor at applicable slab rate. This means that if you are in the 30% tax slab, you will have to pay 30% tax on dividend income.

Hence, if you are in greater than 10% tax slab, you should now opt for Growth plans and use systematic withdrawal plan (SWP) for generating regular income. SWP is more tax efficient as the gains are taxed at 10% (assuming Long Term Capital Gains tax rate) vs. Dividend option (taxed at your slab rate). In SWP, when you receive the amount, it consists appreciation as well as principal. There is no tax on the principal repayment, hence there will always be lesser tax liability.

Purely from the tax perspective, it may seem that investors in less than 10% tax slab will benefit by staying in dividend plan. But considering that tax deduction at source (TDS) at 10% is applicable for dividends exceeding INR 5,000 which needs to be claimed after filing of return. This will make filing tax returns cumbersome. Also, since LTCG is only charged on gains above INR 1 Lakh annually irrespective of tax slab, you may not have to pay any tax on your withdrawals under SWP vs slab rate in dividend plan. Thus, even if you belong to a lower tax bracket it makes sense to switch your investments from dividend to growth plan.

Hence most investors should switch from dividend to growth plans. There may be tax and exit load implications at the time of switching, but these may have negligible overall impact

Illustration:

Assuming that you invest INR 10,00,000 in an Equity Oriented scheme on April 1, 2020 and the scheme grows at 12% p.a. and a cash flow requirement of 8% p.a., the monthly net cash flow after tax under both growth and dividend option would be as follows:

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