SWP vs IDCW Payout – Which option is more tax-efficient?
Earning a passive income is everyone’s dream. It gives you a financial back up and helps achieve your life goals faster.
Oct 2024
3 mins read
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Earning a passive income is everyone’s dream. It gives you a financial back up and helps achieve your life goals faster. A Systematic Withdrawal Plan (SWP) helps you achieve your goal and at the same time helps your corpus compound. This facility is ideal for retirees seeking a steady income, those looking to supplement their regular income, or investors who wish to gradually redeem their investments to avoid paying higher taxes and allow their investments to compound simultaneously.
Let’s understand the impact of NAV on withdrawals
Mutual funds honour SWP commitments by redeeming your units. To understand how many units are redeemed when you withdraw Rs 50,000, you divide the withdrawal amount by the NAV.
Fewer units are redeemed if NAV appreciates while more no. of units are redeemed if NAV declines. Therefore, it's essential to monitor the NAV of the fund to understand the implications of your SWP withdrawals.
Tax implication
Depending on when you start your withdrawals, SWPs may attract exit loads and capital gains, depending on the holding period and amount of withdrawal.
Let’s understand the impact of NAV on withdrawals
Mutual funds honour SWP commitments by redeeming your units. To understand how many units are redeemed when you withdraw Rs 50,000, you divide the withdrawal amount by the NAV.
Fewer units are redeemed if NAV appreciates while more no. of units are redeemed if NAV declines. Therefore, it's essential to monitor the NAV of the fund to understand the implications of your SWP withdrawals.
Tax implication
Depending on when you start your withdrawals, SWPs may attract exit loads and capital gains, depending on the holding period and amount of withdrawal.
The SWP withdrawals are taxed based on capital gains. For equity funds, short-term capital gains (STCG) tax of 20% is applicable for holding period of less than one year, and long-term capital gains (LTCG) tax of 12.5% applies for holding period of more than one year. Also, in equity funds, LTCG of up to 1.25 lakh is tax-free while gains from Debt Funds are taxed as per your income tax slab.
Opting for a SWP from equity oriented funds is more tax-efficient as long term capital gain of up to 1.25 lakh is tax free. Let’s see this with an example.
Assume an investment of 50 lakhs which grows at 12% by the year end. Here is the calculation of the difference between your tax outgo through SWP (capital gains) compared to Income Distribution cum Capital Withdrawal income (assuming all appreciation is paid as IDCW).
Dividends (now IDCW) were a popular choice until the tax liability was shifted to investors from April 1 2020. SEBI changed the nomenclature of dividend in April 2021 to (IDCW) to apprise investors that the payouts were from their own investment value and the NAV falls to that extent. This is the reason why the NAV of Growth options are always higher than Dividend options.
As you can see that you would pay tax of Rs 59,375 if you opt for SWP while you end up paying Rs 1,87,200 if you opt for IDCW payout option, assuming you are in the highest tax bracket.
How long will your corpus last?
With an SWP, the remaining corpus continues to compound over time. Regular withdrawals reduce the capital available for compounding, so careful withdrawal planning is key to maintaining growth. Your withdrawal rate should ideally be the “real rate of return” which is investment return after adjusting for inflation. So if your investment return is say 12% and inflation is 6% then your withdrawal rate should not be more than 6%.
One of the major worries for retirees is to figure out how long their corpus will last once they stop receiving income/salary from their primary occupation. Let’s assume you have accumulated a corpus of Rs 1 crore at the age of 60 and your life expectancy is 85 years. You start withdrawing Rs 60,000 per month with 6% increase in withdrawal every year, from a portfolio yielding 12% CAGR every year, your corpus lasts for 26 years.
It may happen that markets may see higher drawdowns in the initial phase of our investment, which can work against you in terms of the time taken to compound your wealth. Life may throw its own surprises if we encounter some emergency expense and to prepare for such scenarios it is best to have multiple source of cash flows with help of a gig income, rental income, annuities and so on. The annuity rate offered by insurance firms can range from 5.44% to 8.7%, depending on the plan. (Source: PFRDA)
Summing up, SWP is a popular option if you are seeking a steady income stream, especially during retirement. SWPs can help you manage cash flow needs without having to liquidate your entire investment at once, providing a more predictable and disciplined approach to withdrawals. Since the goals, aspirations and financial situation of each individual is unique, it is best to work with a financial advisor who can offer a bespoke plan for your goals.
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All the Mutual Fund investors have to go through a one-time KYC (Know Your Customers) process. Investor should deal only with the Registered Mutual Funds (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit https://www.pgimindiamf.com/ieid.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY. Read more
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