When comparing SWP and Dividend Plans, Dividend Plans involve distributing profits from a mutual fund scheme to its unit holders. Unlike SWP, where investors decide the withdrawal amount, dividends in a mutual fund are declared by the company based on the fund's performance.
Investors invest in mutual funds to generate return on investment (ROI). They can get cash flows from the generated return in two ways:
- Systematic withdrawal plan (SWP)
- Dividend plan (also known as IDCW or Income Distribution cum withdrawal)
To understand which one is better for you, let us first check their definition and how they can help.
SWP vs Dividend plans: What are they?
The definitions of both systematic withdrawal plan and dividend plan are given below:
What are SWP plans?
SWP gives you income regularly. This specialised withdrawal scheme helps you withdraw a fixed amount from your mutual fund’s corpus on a regular interval, say monthly. As an investor, you can choose the frequency at which you want to withdraw money from your mutual fund. The extent of the fixed amount of money that you want to withdraw can also be determined by you.
The process of withdrawing money from a SWP account is done by redeeming units from the mutual fund scheme. The units you redeem are priced as per the current price of the scheme or NAV value on the withdrawal date. It has been seen that in mutual funds, SWPs are most commonly used with the growth option.
What are dividend plans?
Dividend plans are called IDCW (Income Distribution cum withdrawal). These mutual funds provide you with dividend payouts along with appreciation of capital. Unlike SWPs, dividends are not provided regularly (say, monthly). They are announced by Asset Management Companies (AMCs) from time to time, especially every year. When you take out the dividend amount, the NAV (Net Asset Value) of the scheme falls.
Difference between SWP and dividend?
You can differentiate between a systematic withdrawal plan and a dividend on the basis of the following three factors:
1. Flexibility in withdrawal
- SWP
The control over the payout amount and frequency of the withdrawals rests with you. When you choose a SWP plan, the frequency of unit withdrawal is done as per your choice at the time of investing in the scheme. - Dividend plan
The AMC decides the frequency of dividend payout. It is solely dependent upon the extent of profit the scheme is making. This means that there is no assurance of a regular payout. - Verdict
When it comes to regular payout and flexibility, SWP is a better choice than dividend plans.
2. Impact on taxation
- SWP
When you are buying a systematic withdrawal plan, no tax is deducted at source (TDS). In addition, dividends are tax-free. The only tax you have to pay in SWPs is the tax on capital gains. - Dividend plan
When you are opting for a dividend payout plan, your dividends are taxable as per the income tax slab applicable to you. - Verdict
There is nothing tax-free in the case of dividend payouts. No TDS is applicable on SWPs also. In terms of taxation, SWP is the winner.
3. Predictability
- SWP
The payout is certain on a regular interval because it is chosen by you. Hence, you are certain about its payment. The predictability of getting paid on a certain date is certain and extremely high. - Dividend Plan
Dividends are announced by the fund houses and not chosen by the investor. Hence, the dividend payout is not regular and therefore uncertain. - Verdict
If you are a retiree who is looking for a regular income through the regular payouts from your mutual fund, SWP will provide you with way more predictability than a dividend plan.
4. Returns
In a systematic withdrawal plan, you receive a fixed amount regularly by redeeming a portion of your mutual fund units. This amount is predetermined and doesn't change based on market performance. On the other hand, with dividends, the amount you receive depends on the mutual fund’s profits. The returns are not fixed and can vary, as dividends are paid from the profits made by selling the underlying assets.
5. Suitability
SWPs are ideal for those who want a steady income, like retirees. Since the withdrawal amount is fixed, it often acts as a substitute for a pension and offers predictable income. In comparison, the dividend option suits individuals who are comfortable with receiving income at irregular intervals. However, be aware that this amount is not fixed and will vary according to the mutual fund’s performance.
6. Capital erosion
SWPs can lead to capital erosion since the withdrawals reduce your original investment. You are taking out a portion of your own money, which reduces your investment value over time. Conversely, dividends do not erode your capital. The dividends are paid from the fund's profits, so your initial investment remains intact.
7. Reduction in NAV
In an SWP, there is no direct impact on the Net Asset Value (NAV) of the mutual fund. However, your investment decreases as you redeem units. On the other hand, when dividends are paid out, the mutual fund’s NAV reduces. This reduction happens because the profits distributed were part of the fund’s value. It leads to a lower NAV post-distribution.
8. Type of scheme
People using SWP usually prefer low-risk mutual funds like liquid or ultra-short-term funds. Such a choice ensures their capital remains stable. Also, these funds offer predictable returns and are less volatile. Comparatively, for dividends, investors often choose from various mutual fund schemes based on their risk appetite and investment duration. This can range from high-risk equity funds to low-risk debt funds, depending on their financial goals.
9. Frequency
SWPs are flexible, and you can customise the frequency of withdrawals in an SWP to suit your needs, such as weekly, monthly, or quarterly. Meanwhile, dividend payments have a fixed frequency decided by the mutual fund, such as daily, monthly, or yearly dividends. You don’t have control over when dividends are paid.
10. Discontinuing the option
You can easily stop SWPs whenever you want and withdraw the entire investment if needed. However, stopping dividends is harder because it’s tied to the type of mutual fund scheme. The only option to stop dividends is by redeeming your entire investment in the scheme.
11. Disciplined withdrawal habit
SWPs encourage disciplined withdrawals, as you only take out a fixed amount regularly. By sticking to this fixed schedule and amount, you avoid the temptation to withdraw too much or too little at random times. This way, you manage your finances more consistently over time. In comparison, dividends do not promote disciplined withdrawals. Since the amounts vary based on the fund’s performance, it usually leads to irregular income.
Differences between SWP and dividend - A summarised table
SWP and dividend plans are two distinct investment options. To gain more clarity about their key differences, let’s study the table below:
Aspects |
SWP |
Dividends |
Returns |
Investors can withdraw a fixed amount regularly |
The amount varies and depends on the mutual fund’s performance |
Suitability |
One of the best options for retirees who are looking for a fixed and regular income source |
Ideal for investors looking for periodic income |
Capital erosion |
Yes, it can reduce the initial investment or capital |
No, capital remains intact |
Reduction in NAV |
No, the NAV of the mutual fund remains unchanged |
Yes, NAV reduces after dividend has been paid |
Type of scheme |
Usually, low-risk schemes are preferred, like liquid funds |
Investors can pick any scheme based on their risk tolerance and investment horizon |
Frequency |
Withdrawals are flexible and can be made monthly, quarterly, weekly, etc. |
The payment of dividend is pre-decided by the mutual fund and can be done daily, weekly, monthly, etc. |
Stopping |
Withdrawals can be stopped anytime |
To stop dividends, investors must redeem their entire investment |
Disciplined withdrawal |
Promotes disciplined withdrawal |
Creates irregular source of passive income |
Pros and Cons of SWP
A Systematic Withdrawal Plan (SWP) allows investors to withdraw fixed amounts from their mutual fund investments regularly. It offers flexibility but comes with certain drawbacks.
Pros:
- Regular income: Provides steady payouts, ideal for retirees or those seeking predictable cash flow.
- Flexibility: Investors can decide withdrawal amounts and frequency.
- Customisation: Tailored to meet individual financial needs, ensuring control over investments.
Cons:
- Capital erosion risk: High withdrawals can deplete investment capital.
- Tax implications: Withdrawals may attract short-term or long-term capital gains tax.
- Market dependency: Withdrawals during market downturns might reduce the value of remaining investments.
Pros and Cons of dividend plans
Dividend plans distribute a portion of mutual fund earnings periodically, making them suitable for investors seeking periodic returns.
Pros:
- Periodic returns: Ensures a flow of income at intervals.
- No manual intervention: Dividends are automatically credited to investors’ accounts.
- Encourages passive income: Ideal for those seeking income without withdrawing capital.
Cons:
- Irregular payouts: Dividends depend on fund performance and may vary.
- Tax inefficiency: Dividends are taxed at the investor's slab rate.
- Capital growth impact: Frequent payouts may hinder long-term wealth accumulation.
What to choose between SWP and Dividend Plan?
Income needs
When choosing between a Systematic Withdrawal Plan (SWP) and a Dividend Plan, consider your income requirements. SWP provides a steady income by allowing you to withdraw a fixed amount at regular intervals, offering predictable cash flow. In contrast, Dividend Plans pay dividends when the fund declares them, resulting in variable income. If you need consistent income, SWP is a more suitable option.
Tax planning
Tax implications differ for SWP and Dividend Plans. SWP withdrawals may attract capital gains tax based on the holding period, with lower rates for long-term holdings. Dividend income, on the other hand, is taxable according to your income slab. For investors in higher tax brackets, SWP might be more tax-efficient as capital gains could be lower than dividend distribution tax.
Market outlook
Consider market conditions when deciding. SWP withdrawals involve selling fund units, which can be disadvantageous in a falling market as it could lead to capital erosion. Dividend Plans, however, distribute income without liquidating units, making them potentially beneficial during market downturns. If market stability is a concern, Dividend Plans may be more suitable.
Reinvestment strategy
Your reinvestment approach also matters. SWP provides a fixed income, allowing better control over your investment strategy, enabling you to reinvest based on your needs. Dividend Plans reinvest profits into your portfolio automatically if you choose a reinvestment option. If you prefer deciding when and how to reinvest, SWP gives you more control.
Risk tolerance
Your risk appetite plays a crucial role. SWP allows you to tailor withdrawal amounts to suit your risk tolerance, potentially preserving more capital over time. Dividend Plans may suit investors seeking a less active management style, where income is generated based on the fund’s performance rather than regular withdrawals.
Which is better - SWP or Dividend?
Most mutual fund investors find it challenging to pick the right option between SWP and dividends. For many, the two options seem similar, but there are significant differences between SWPs and dividends.
In SWPs, investors set up a plan to withdraw a fixed amount of money from their mutual fund investment at regular intervals, like monthly or quarterly. This way, they get steady and predictable income, which makes it ideal for retirees or those seeking consistent cash flow.
On the other hand, the dividend option pays investors a portion of the mutual fund’s profits whenever the fund decides. Usually, it results in irregular and varying income amounts.
One of the key differences you must understand revolves around how and when money is credited to the investor’s account. With SWP, the investor has control over the amount and frequency of withdrawals. However, dividends are paid out based on the mutual fund’s performance. This implies that investors have less control over the timing and amount.
Hence, dividends might be more suitable for those who don’t need regular income but appreciate occasional payouts. Meanwhile, SWPs offer more predictable income and are better suited for those relying on their investments for steady cash flow.
Reasons why SWP is better than dividend plan
A Systematic Withdrawal Plan (SWP) offers more reliability and control compared to dividend plans, making it a preferred choice for many investors. Here’s why:
- Surety of fixed payout
SWP provides a predetermined and consistent withdrawal amount, ensuring financial predictability. Unlike dividends, which depend on fund performance, SWP ensures payouts regardless of market conditions. - Taxation
SWP withdrawals are taxed as capital gains, which often have lower rates than dividend taxation. Dividends are taxed as per the investor’s income slab, which may result in higher tax liabilities for high-income individuals. - Avoid market risk
SWP mitigates market risk as it allows withdrawals without relying on fund performance. Dividends, being performance-based, may leave investors without returns during a downturn, causing financial uncertainty. - Financial independence for your family members
SWP ensures a regular income stream for family members, especially retirees or dependents, offering financial stability. Dividend plans, due to their inconsistency, may not provide the same level of independence.
Final words
In the above discussion, we have seen that SWP is a better option for you if you are a retiree who is looking for a regular income or cash flow, say, every month. This is because both the interval of payout and the amount is decided by you. The predictability of regular income and flexibility of payout are significantly higher in the case of SWPs than dividend payout plans. The amount of tax you have to pay is significantly lower for SWPs than dividend plans because the dividends of SWPs are tax-free and no TDS is applicable to the regular payouts of SWPs.
