IDCW or SWP which is better option to generate regular income from Mutual Funds?

IDCW or SWP which is better option to generate regular income from Mutual Funds?

Monthly cash flows from investments is a critical need of many investors, especially retirees. Mutual Funds are a great vehicle when it comes to receiving periodic cash flows. While many investors choose the Dividend Option, also known as Income Distribution cum Capital Withdrawal (IDCW), we argue that a Systematic Withdrawal Plan (SWP) from the Growth option of an Mutual Fund scheme could be a better alternative.

Understanding IDCW

IDCW is paid from a Scheme’s distributable surplus. The scheme cannot distribute dividend in IDCW plan just because Net Asset Value (NAV) has appreciated but IDCW plan must have distributable reserves. Distributable reserve is nothing but aggregate total of income accruals (Dividend / Interest Income), accumulated & realized profits, income equalization reserve for IDCW plan. Further, not entire profits are distributed as IDCW, some portion is kept in reserve to maintain continuity in distribution of IDCW. Investors must realize, IDCW is a periodic distribution that forms a part of scheme returns. Any IDCW declaration would reduce the NAV of the scheme to the extent of such distribution and statutory levy, if any. Investors may note that under Income Distribution cum Capital Withdrawal options the amounts can be distributed out of investor’s capital (Equalization Reserve), which is part of sale price that represents realized gains.

SWP – You Decide How Much You Wish to receive Every Month

SWP allows investors to withdraw a fixed amount at a regular frequency. The SWP generate cash flow by redeeming units of the scheme at regular frequency based on NAV of the scheme. Whether the market is up or down, there is continuity in cash flows. Cashflows may continue, till there are adequate number of units or completion of tenure of SWP, whichever is earlier. It is also important to know, that your corpus may decrease over a period of time if your SWP withdrawal rate is higher than the returns generated by the Scheme. What’s more? Your SWP is tax efficient as taxation is applied only on the appreciation component of your monthly withdrawal. With IDCW, your entire cash flow is subject to marginal rate of taxation.

A Comparison Snapshot: The table below shows the difference between withdrawing money regularly through SWP and IDCW:

* As per prevailing tax laws, in view of individual nature of tax consequences, each unit holder is advised to consult their own professional tax advisors.

Tax Impact Explained Say, you invested Rs.1,00,000 and start withdrawing Rs.1000 every month.

Note: SWP is Systematic Withdrawal Plan. IDCW is Income Distribution cum Capital Withdrawal. Short Term Capital Gains Tax rate assumed at 15% and IDCW is assumed at highest Tax bracket at 30%. Cess and Surcharge is excluded for simplicity purpose. Short Term Capital Loss is adjusted against Short Term Capital Gain. Calculation is based on notional NAVs. IDCW is assumed to pay from distributable surplus. The above table is for illustration purpose only purely to explain the concept of SWP and should not be construed as providing any kind of investment advice or as a substitute for any kind of financial planning. HDFC Mutual Fund/HDFC AMC is not guaranteeing any returns on investments made in the Scheme. The result of the calculations generated in the above illustration may not be accurate. Calculations are based on assumptions provided above. Due to the personal nature of investments and financial planning, investors are advised to consult their Mutual Fund Distributor / Registered Investment Advisor.

Although, value of investment remains same for SWP and IDCW option at the end of Jan 1, 2023 but SWP works out to be a tax efficient solution to structure regular payouts. Also, overtime the principal component decreases giving way to taxable income component. It is advisable to start SWP after completion of 1 year so that gains can be taxed under Long Term Capital Gains for hybrid schemes which have gross equity exposure of >=65%.

Another important point: Before choosing between IDCW payout or SWP as to which is better, an investor needs to assess whether they actually require monthly cash flows from investments. Many investors simply choose the IDCW option without much thinking about the tax implications. If you are salaried or generate adequate income from a business to cover your monthly expenses, it may be better to simply invest in the Growth Option of a Mutual Fund Scheme. You may neither need an IDCW or SWP and let your investments grow over a period of time.

Did You Know? Our range of Hybrid Funds have SWP friendly exit load structure i.e. in respect of each purchase/switch-in of units, upto 15% of the units may be redeemed without any exit load from date of allotment. Any redemption in excess of the above limit shall be subject to applicable exit load. To know exact load structure and scheme details, visit www.hdfcfund.com

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.