Mutual funds are an ideal market-linked investment tool when it comes to receiving cash flows on a periodic basis, especially for retirees.
Generally, investors have the choice of the dividend option, also referred to as Income Distribution cum Capital Withdrawal (IDCW), as well as a Systematic Withdrawal Plan (SWP) from the growth option of a mutual fund scheme.
Normally, IDCW is paid from the distributable surplus of a mutual fund scheme. However, the scheme will not distribute dividend in IDCW plan due to a mere rise in the net asset value (NAV). The IDCW plan is requited to have distributable reserves to initiate the dividend distribution process.
The distributable reserve refers to the aggregate total of income accruals, which includes dividend and interest income, accumulated and realised profits, income equalisation reserve for IDCW plan.
In addition, complete profits are not distributed as IDCW. A portion is held back as reserve to ensure the distribution of IDCW remains an ongoing process.
Essentially, IDCW is a periodic distribution that makes a part of scheme returns. The declaration of IDCW declaration tends to have an influence on the NAV of the mutual fund scheme while reducing it to the extent of such distribution and statutory levy.
As per the IDCW option, the amounts can be distributed out of investor’s capital, referred as equalisation reserve, which is part of sale price that highlights realised gains.
On the other hand, through SWP, it is possible for investors to withdraw a fixed amount on a regular basis. The SWP generate cash flow through redemption of units of the scheme at regular frequency on the basis of the NAV of the scheme.
In this case, the continuity in cash flow remains unaffected by the fluctuations in the equity market. Cashflows will continue till there are adequate number of units or completion of tenure of SWP, whichever is earlier.
At the same time, the corpus may witness a dip over a period if the SWP withdrawal rate is higher than the returns generated by the mutual fund scheme.
In addition, SWP is considered tax-efficient as taxation is applicable only on the appreciation component of the monthly withdrawal. In addition, exemption of Rs 1 lakh is available under the long-term capital gains (LTCGs). However, in the case of IDCW, no exemption is available under the LTCGs and the complete cash flow is subject to marginal tax rate.
As an investor, it is crucial to assess whether they actually require monthly cash flows from investments before choosing between IDCW payout and SWP.
Also, an investor needs to be mindful of the tax implications that IDCW option attracts. Ideally, a salaried individual or a businessman having sufficient income to cover their monthly expenses is better off by investing in the growth option of a mutual fund scheme rather than opting for an IDCW or SWP.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.