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In short, SWP is a better plan than the Monthly Dividend Option. Let us see how.
Monthly Dividend Plans:
Mostly retired people pull out their hard earned money and proceedings from their retirement corpus and invest a lump sum into a popular hybrid fund which gives them good monthly dividends. This is one of the very popular avenues available for retail investors or for those investors who require a regular cash flow to meet their routine domestic expenses. So far, the dividend received through these plans was tax free but from this financial year onwards, the tax status of these dividend plans has been changed.
Systematic Withdrawal Plan (SWP):
As indicated above, from this financial year, dividend distribution tax of around 10% is applicable for all the dividend distributed by equity mutual funds. It is taxed at the source level, and in the hands of the investor, the dividend money received is tax free. However, this tax is being paid indirectly by the investor through the profits he makes in mutual funds. Most of us have read or heard about this already. It has already been recommended to investors to move from dividend schemes to growth schemes to avoid the dividend distribution tax. But every action has its own merits and demerits and in the growth schemes, there is no cash flow to the investors until redemption is done by the investor. This is not suitable for some investors. They require regular cash flows month in month out to meet their domestic expenses. What is an alternative available for this class of investors? They can move to growth schemes and do Systematic Withdrawal.
SWP is nothing complex and we get fixed cash from the mutual fund houses on fixed date at regular intervals. This is very similar to SIP. In SIP, we pay month in month out to mutual fund houses. In SWP, the mutual fund houses will pay the investor month in month out. The important point to note here is that a fixed amount on the fixed date will be paid by the mutual fund to the investor irrespective of whether the fund is making a profit or not. This raises another question. If there is no profit, how will we get money from the fund? The money is taken from the principal we’ve paid or from the redemption of our units. Yes, it is a tricky concept and it is not acceptable to some and it is not understood by some.
Let’s see one example of both SWP and Monthly Dividend Option to understand this concept in a better way.
Let’s take ICICI Prudential Balanced Advantage Fund data for 4 years from 20/OCT/2014 till today.
Tidbits:
Currently it seems a lot of investors have entered in to the Monthly Divided Option of Hybrid Funds on the expectations of getting 12% monthly return. It is not realistic in the current junction where markets are pretty weak. Expecting 12% yearly returns from hybrid monthly dividend plans is not practical. The investors have to tone down their return expectations to around 7-10% on average.
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In short, SWP is a better plan than the Monthly Dividend Option. Let us see how.
Mostly retired people pull out their hard earned money and proceedings from their retirement corpus and invest a lump sum into a popular hybrid fund which gives them good monthly dividends. This is one of the very popular avenues available for retail investors or for those investors who require a regular cash flow to meet their routine domestic expenses. So far, the dividend received through these plans was tax free but from this financial year onwards, the tax status of these dividend plans has been changed.
Systematic Withdrawal Plan (SWP):
As indicated above, from this financial year, dividend distribution tax of around 10% is applicable for all the dividend distributed by equity mutual funds. It is taxed at the source level, and in the hands of the investor, the dividend money received is tax free. However, this tax is being paid indirectly by the investor through the profits he makes in mutual funds. Most of us have read or heard about this already. It has already been recommended to investors to move from dividend schemes to growth schemes to avoid the dividend distribution tax. But every action has its own merits and demerits and in the growth schemes, there is no cash flow to the investors until redemption is done by the investor. This is not suitable for some investors. They require regular cash flows month in month out to meet their domestic expenses. What is an alternative available for this class of investors? They can move to growth schemes and do Systematic Withdrawal.
SWP is nothing complex and we get fixed cash from the mutual fund houses on fixed date at regular intervals. This is very similar to SIP. In SIP, we pay month in month out to mutual fund houses. In SWP, the mutual fund houses will pay the investor month in month out. The important point to note here is that a fixed amount on the fixed date will be paid by the mutual fund to the investor irrespective of whether the fund is making a profit or not. This raises another question. If there is no profit, how will we get money from the fund? The money is taken from the principal we’ve paid or from the redemption of our units. Yes, it is a tricky concept and it is not acceptable to some and it is not understood by some.
Let’s see one example of both SWP and Monthly Dividend Option to understand this concept in a better way.
Let’s take ICICI Prudential Balanced Advantage Fund data for 4 years from 20/OCT/2014 till today.
Description
|
SWP
|
MD
|
Remarks
|
Intial investment
|
10,00,000
|
10,00,000
|
|
Cash received by investor
|
3,36,000
|
2,98,676
|
Swp withdrawel 7000 per month -48 payout - avg cash floow 6100 - 49 payout
|
Current value
|
10,13,805
|
10,38,783
|
|
Return -xirr
|
9.11%
|
8.63%
|
|
Intial units
|
42,608
|
76,046
|
|
Final units
|
30,843
|
76,047
|
|
Intial NAV
|
23.47
|
13.15
|
|
Final NAV
|
32.87
|
13.66
|
|
CG
|
85,873
|
0
|
CG with respect to withdrawal
|
Tax
|
0
|
29,867.60
|
10% DDT paid by the fund no tax in the hands of
investor
|
Simple gain higher than MD plan
|
12,346
|
Cash flow on fixed dates - In the Monthly Dividend Option, the dividend distribution is not uniform.
- Sometimes we will get the dividend in the first week of the month (example 4th April 2018).
- In some other cases, we will get the dividend at the last week of the month (example 28 September 2018).
- In worst cases, we won’t get any dividend at all (example Feb and March of 2016).
- On contrary, in the month of April we got two dividend distributions.
So, it is very clear that even though it is called Monthly Dividend Option, the distribution of income in the form of dividend is not on a fixed date and it is very random depending upon the fund house and fund manager’s discretion. At the same time in the case of SWP, we get the cash on fixed dates.
Cash flow to meet regular expenses:
In Monthly Dividend Option, like the dividend distribution date is not fixed, the amount of dividend distributed every month also varies in a wide range, depending upon the surplus profit made by the fund. In our example, the maximum dividend distributed was in May 2016 and was around Rs.12000. Whereas, the lowest amount distributed was only Rs.1500. It is very difficult to meet the monthly expenses with this irregular cash flows. In SWP, we can decide how much cash flow we would need and we can fix this. It is advisable to fix this amount closer to the average profit made by the fund, so monthly we will be getting a fixed cash flow in to our bank account.
Units and Values Investment:
Conceptually, between Monthly Dividend Option and SWP, in the case of Monthly Dividend Option, the total units held by the investor is the same. Whereas, in the case of SWP, the units will get reduced. In both cases the value is very similar because, in the case of Monthly Dividend Option, the NAV is more or less same, and in the SWP case, the NAV is increasing. This will off set reduction in units because it is a growth based plan.
Taxes and Cash Flows:
In the case of Monthly Dividend distribution, dividend distribution tax is paid by the fund house from the fund’s surplus profits. Part of the profits is distributed to the investor as dividend. This tax is applicable from April 2018. The table given above has two parts. One part is based on the data before dividend distribution tax (till March 2018) and the other from April 2018 to September 2018 (based on dividend distribution after paying taxes). Hence, because of dividend distribution tax, the investor might receive slightly less cash going forward. In the case of SWP, capital gains gained by the investor up to 1 lakh are tax free. It is better to withdraw the investments after one year to avail this benefit.
Final verdict on comparison between Monthly Distribution Option and SWP option:
- SWP is better
- Return is more in SWP
- Steady cash flow each month in SWP
- Tax efficient
- Uneven dividend in MD plan
- Amount varies in MD plan
- Date of cash flow to investor varies in dividend plan
- These workings are not taking in to tax paid as ddt tax in md option and capital gain tax paid in SWP - which usually less
Tidbits:
Currently it seems a lot of investors have entered in to the Monthly Divided Option of Hybrid Funds on the expectations of getting 12% monthly return. It is not realistic in the current junction where markets are pretty weak. Expecting 12% yearly returns from hybrid monthly dividend plans is not practical. The investors have to tone down their return expectations to around 7-10% on average.
If you like this article, please share this on your Facebook or Twitter. This would be a special gift which you would be giving to our blog.
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