For regular income, systematic withdrawal plans are better

With a tax incidence of 10 per cent on dividend income, this is a good way to lower tax liability

From April 1, mutual fund investors who had chosen the dividend option in equity funds will have to pay a flat 10 per cent tax on the payouts they receive. Those who don't need the money should immediately shift to the growth option and redeem only when there is a need. Those who chose the dividend option because they needed a regular income should shift to a systematic withdrawal plan (SWP), which is a more tax- efficient option. In SWP, the tax is calculated only on the capital gains and not on the entire amount that is received from a fund. This lowers the tax incidence. In the dividend option, on the other hand, the investor pays tax on the entire amount received. Say, you invested ~800,000 in an equity mutual fund scheme with a net asset value of ~80. You could have 10,000 units of the scheme. Once the NAV reaches ~100 and you initiate an SWP of ~1,000 (100 units) per month, you would get ~12,000 in one year. However, since the taxation is only on the capital gains, you would pay ~360 (15 per cent on ~2,400 in the case of short-term capital gains). In case of longterm capital gains, the amount would be ~240 (see table). On the other hand, there is a tax incidence of ~1,200 in case of dividend tax.

In the SWP option, the investor gets a fixed amount regularly. In the dividend option, the periodicity and amount of dividend payment is determined by the fund house and can't be controlled by the investor. Fund houses can only pay dividends out of surpluses generated by the fund, and in case of a downturn, the fund house is free to stop payouts. Another benefit of SWP is that your total longterm capital gains up to ~100,000 will not be taxed. Under the dividend option, any money you receive will get taxed.

According to Suresh Sadagopan, founder, Ladder7 Financial Advisories, "Investors should not, in the normal course, rely on equities for regular income. When an equity fund is giving negative returns, any withdrawal at that juncture could possibly eat into the capital. For regular income, investors should go for an SWP in a short-term debt fund." Since a short-term debt fund is less volatile, the risk of eroding your capital in case of a market downturn is lower. SWP in a debt fund will also be more tax efficient. The LTCG tax rate on debt funds can be lower than the rate on equity funds after a few years of investment due to the indexation benefit.

Some investment managers, however, suggest it is okay to use an SWP in equities, provided the investor has accumulated significant gains after a few years of investment. In that case, he is more likely to withdraw from his gains and there is less risk of eroding capital. Also, the investor should withdraw an amount much lower than the gains made. If your average equity returns in the past have been 10-12 per cent, you should withdraw only 1-3 per cent of the corpus a year. This will allow your corpus to continue growing. If you have a corpus of ~10 million, at the most you should look to withdraw ~200,000-300,000 annually.

In fact, SBI Mutual Fund has recently introduced the Bandhan SWP to help customers with their monthly cash flows. Investors can withdraw any amount above ~5,000 a month. They can also transfer withdrawals to immediate family members like parents, spouse or children, and there will be no tax in the hands of the recipient.