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Illustration Showing Tax-efficiency Of SWP Compared To Dividend Option
In case of a normal dividend payout the dividend amount is distributed which the investor receives as income and the units that he has bought are left intact. As against this, when one withdraws some amount under SWP, there is a simultaneous reduction in the number of units being held by the investor. But the real benefit would be on the tax aspect. So far, dividends being tax free was a better option as the addition to the income is nil but once this is taxable, then the investor would be far better off using the withdrawal route. We shall make the use of an example to highlight the way in which the two options actually work.
Let us assume a case where an investor goes in for a monthly dividend payout scheme of an Income Fund. The amount invested at the beginning of the period is Rs. 1 lakh. For the purpose of this example, the net asset value (NAV) of the fund at the time of purchase is considered as Rs.15, which means that a total of 6,666.67 units are allotted to the investor. Under the dividend plan, dividend is distributed, say @1% i.e. there is a payment of Rs. 666.67 each month for a period of 12 months amounting to Rs. 8,000 over a one-year period. As per the budget where dividend is sought to be taxable in the hands of the investor, the entire amount would be taken as income and charged to tax as per respective tax bracket of him. In our example, it is assumed to be 31.5%. As seen from the table, the post-tax income in the hands of the investor is Rs. 5480.
In the second option, the investor opts for growth option of the Income Fund and redeems units allotted to him by an amount equivalent to Rs. 666.67 each month. Thus the payout remains the same. The net asset value of the fund is assumed to increase by 10 paise every month and at the end of every month the redemption takes place at the prevailing net asset value. According to this calculation, at the end of the first month the NAV is Rs. 15.10. When the redemption occurs at this stage, an amount of Rs. 666.67 is paid out, but just Rs. 4.42 becomes his taxable income (as against the Rs. 666.67 in case of dividend). The reason behind this is that every withdrawal results in short-term capital gain, which is the difference between the withdrawal amount and the respective cost of acquisition and taxed as per respective slab applicable to the investor. The same process continues every month. Looking at the table, one can see that while the dividend option would result in Rs. 5480 as post-tax income, a similar payout in the second scheme would add an amount of Rs. 7907 as the post-tax income.
After 12 months, the balance units can be redeemed, but the redemption proceeds would be considered as long-term capital gain and taxed at a lower rate of 10% or 20% with indexation, whichever is lower. As seen from the table, the post-tax value of the balance units is Rs. 98,976. So the total post-tax value of investment is higher in case of 'Systematic Withdrawal Plan' than 'Dividend' option. However, one has to remember that, in the dividend case the number of units remains static at 6,666.67 during the whole process but the NAV keeps falling after every dividend payout while in the second case, the number of units goes on decreasing but value wise, the reduction in units is compensated by the increase in the NAV of the fund. So it is clear, that in the current context when dividends are no longer tax-free at the hands of investors, Systematic Withdrawal Plans can surely provide a solace in the mayhem to the investors seeking regular returns from their investments.