Regular Income From Mutual Funds: Comparing IDCW And SWP Options

By Chakrivardhan KuppalaMutual fund investors often aim to grow wealth over the long term through systematic investments. However, many investors seek a regular income stream from their mutual fund investments. For such scenarios, two options are commonly considered: the Income Distribution Capital Withdrawal (IDCW) option and the Systematic Withdrawal Plan (SWP). Understanding the nuances of these options is crucial in choosing the right one based on financial goals and tax implications.Understanding the Options: IDCW and SWPIDCW (Income Distribution Capital Withdrawal)Previously known as the Dividend Plan, IDCW distributes earnings generated by the mutual fund scheme at regular intervals. The payout frequency and amount are decided by the Asset Management Company (AMC), and the distribution amount is deducted from the fund's Net Asset Value (NAV). This means that the NAV reduces proportionally to the dividend payout. While IDCW provides a sense of steady income, it offers limited flexibility as the frequency and payout amount are not under the investor's control.Systematic Withdrawal Plan (SWP)An SWP allows investors to withdraw a fixed amount from their mutual fund investment at predetermined intervals. Unlike IDCW, where income depends on the AMC's decision, SWP offers the flexibility to choose the withdrawal amount and frequency. The NAV remains unaffected by withdrawals; instead, the number of units held by the investor reduces. This systematic and predictable cash flow makes SWP a preferred choice for those seeking regular income without relying on AMC's discretion.IDCW vs. SWP: How Do They Work?Let's understand the mechanics of both options using a hypothetical scenario:An investor holds 10,000 units of a mutual fund with a NAV of Rs 100 per unit. This amounts to a total corpus of Rs 10,00,000.IDCW PlanIf the mutual fund announces an IDCW payout of Rs 5 per unit, the distribution will amount to Rs 50,000 (Rs 5 x 10,000 units). After the payout, the NAV drops by Rs 5 to Rs 95 per unit, bringing the new corpus value to Rs 9,50,000.SWP in a Growth PlanSuppose the investor has set a quarterly withdrawal of Rs 50,000. This withdrawal will require redeeming 500 units (Rs 50,000 ÷ Rs 100 NAV). The NAV remains unchanged at Rs 100, but the number of units reduces to 9,500 (10,000 - 500 units). The remaining corpus stands at Rs 9,50,000, similar to the IDCW option, but the difference is that the withdrawal frequency and amount are determined by the investor.Taxation Impact: IDCW vs. SWPTax implications play a significant role in determining the suitability of these options:IDCW PlanIDCW payouts are taxed at the marginal tax rate of the investor. For example, if a mutual fund scheme distributes Rs 2,00,000 in a financial year, and the investor’s income falls under the 30 per cent tax bracket, the entire payout will be taxed at 30 per cent + cess. This can substantially reduce the effective return, making IDCW less tax-efficient, especially for those in higher tax brackets.SWP in a Growth PlanIn SWP, taxation depends on the capital gains realized on each withdrawal. For equity funds, if the gains are held for more than a year, it qualifies for Long-Term Capital Gains (LTCG) taxed at 10 per cent (after an exemption of Rs 1 lakh). If held for less than a year, it is classified as Short-Term Capital Gains (STCG) and taxed at 15 per cent. In our example, if the investor withdraws Rs 2,00,000, and the initial investment value was Rs 1,50,000, the capital gain is Rs 50,000, which will be subject to capital gains tax based on the holding period.Scenario Analysis: Which Option is Better?Choosing between IDCW and SWP depends on several factors, including the investor’s income tax bracket, need for regular income, and flexibility. Below is a comparison:FeatureIDCWSWPCash FlowsDecided by AMCDetermined by the investorFlexibilityLow – payout depends on the AMC’s decisionHigh – amount and frequency set by the investorPausing/Resuming WithdrawalsCannot be paused; need to redeem the entire fund to stop payoutsCan be paused/resumed anytimeTaxationTaxed at investor’s marginal tax rateSubject to capital gains tax based on holding periodImpact on NAVNAV decreases with every dividend payoutNAV remains the same; number of units reducePractical Example: Choosing Between IDCW and SWPConsider an investor named Rajesh, a retiree looking for a steady income source from his Rs 15 lakh corpus. He has two options:Opt for IDCW: Rajesh selects a mutual fund that pays out Rs 50,000 annually. Since he is in the 30 per cent tax bracket, his effective post-tax return from IDCW will be Rs 35,000 (Rs 50,000 - 30 per cent tax).Opt for SWP: Rajesh chooses to withdraw Rs 50,000 through an SWP in a Growth Plan. Assuming a capital gain component of Rs 20,000 and a holding period of over 1 year, his effective tax liability will be Rs 2,000 (Rs 20,000 x 10 per cent). This means his post-tax return will be Rs 48,000 (Rs 50,000 - Rs 2,000).Clearly, Rajesh benefits more from the SWP option in this scenario.When to Opt for IDCW and When to Choose SWP?For Individuals in Lower Tax BracketsIDCW may be a viable option if the investor falls in a lower tax bracket and doesn’t need high flexibility in cash flows.For Individuals in Higher Tax BracketsSWP is generally more tax-efficient, offering flexibility in determining cash flows and minimizing tax liabilities.Long-term Wealth AccumulationNeither IDCW nor SWP is optimal for long-term growth, as both involve withdrawing funds, which could reduce the corpus significantly, especially in a bear market.Finding the Right BalanceFor those looking to generate a steady income stream, the Systematic Withdrawal Plan (SWP) stands out due to its tax efficiency, flexibility, and control over cash flows. IDCW, on the other hand, may appeal to conservative investors comfortable with lower flexibility and those in lower tax brackets. Ultimately, selecting between the two should depend on individual needs, risk appetite, and tax considerations.The author is the co-founder and executive director, Prime Wealth Finserv Pvt. Ltd [Disclaimer: The opinions, beliefs, and views expressed by the various authors and forum participants on this website are personal and do not reflect the opinions, beliefs, and views of ABP News Network Pvt Ltd.]