Choosing between SWP and IDCW for Retirement Income: Which is better?

When planning for retirement, ensuring a steady income stream is crucial for financial stability and peace of mind. Two common methods employed for generating regular income from mutual funds are Systematic Withdrawal Plans (SWP) and Income Distribution Cum Withdrawal (IDCW) plans. Let’s delve into the specifics of each

Systematic Withdrawal Plan (SWP)

A Systematic Withdrawal Plan (SWP) entails setting up a standing instruction with the Asset Management Company (AMC) to withdraw a predetermined amount at regular intervals from your mutual fund investment. This method provides you with a level of control over your withdrawals, allowing you to tailor the frequency and amount according to your retirement income needs.

You have the autonomy to decide the withdrawal frequency and amount based on your financial requirements. SWP allows for flexibility in adjusting withdrawal amounts or stopping withdrawals altogether if circumstances change. Taxation occurs only upon withdrawal, and it’s based on the capital gains component. This can potentially result in lower tax liabilities compared to other methods.

Income Distribution Cum Withdrawal (IDCW) Plan

An Income Distribution Cum Withdrawal (IDCW) plan involves receiving periodic dividends from your mutual fund investment, with the option to withdraw the dividends as regular income. However, the frequency and number of dividends are determined by the fund’s performance and the discretion of the AMC.

The investor receives periodic dividends from the mutual fund based on its performance. Unlike SWP, investors have limited control over the timing and amount of withdrawals, as these are determined by the fund’s dividend distribution policies. Dividends are added to the investor’s taxable income and are taxed at their applicable slab rate. This can result in higher tax liabilities compared to SWP, especially for investors in higher tax brackets.

Considerations for Choosing Between SWP and IDCW

Control vs Dependence

SWP offers more control to investors, allowing them to tailor withdrawals according to their needs. IDCW, on the other hand, depends on the fund’s performance and AMC’s dividend distribution policies.

Flexibility 

SWP provides flexibility in adjusting withdrawal amounts and frequency, whereas IDCW may have a fixed dividend distribution schedule.

Tax Implications

SWP may offer potential tax advantages as taxation occurs only upon withdrawal and is based on capital gains. In contrast, IDCW dividends are taxed as part of the investor’s regular income, potentially leading to higher tax liabilities.

let’s illustrate both SWP and IDCW plans with a simplified mathematical example, including tax implications:

Example Scenario:

Initial Investment: Rs 100,000 in a mutual fund.

Annual Growth Rate of Fund: 8%.

Withdrawal Rate: Rs 10,000 annually.

Tax Rate: 20% on capital gains and 30% on dividends.

SWP Plan

Yearly Withdrawal: Rs 10,000

Tax Calculation:

• Capital Gains: Rs 10,000 (Withdrawal) – Rs 8,000 (Growth) = Rs 2,000
• Tax on Capital Gains: Rs 2,000 * 20% = Rs 400
• Net Withdrawal After Tax: Rs 10,000 – Rs 400 = Rs 9,600

IDCW Plan

Dividend Distribution: Assuming the fund distributes a 5% dividend annually.

Dividend Amount: 5% of Rs 100,000 = $5,000

Withdrawal: Rs 5,000 (Dividend) + Rs 5,000 (additional withdrawal)

Tax Calculation:

• Tax on Dividends: Rs 5,000 * 30% = Rs 1,500
• Tax on Capital Gains (Assuming no withdrawal): Rs 8,000 * 20% = Rs 1,600
• Net Withdrawal After Tax: Rs 10,000 – Rs 1,500 = Rs 8,500

Comparison

• SWP Net Withdrawal After Tax: Rs 9,600
• IDCW Net Withdrawal After Tax: Rs 8,500

In this example, the SWP plan results in a higher net withdrawal after tax compared to the IDCW plan. This is because SWP allows for taxation only on the withdrawn amount’s capital gains, potentially resulting in lower tax liabilities compared to IDCW, where dividends are taxed at a higher rate. However, actual outcomes may vary based on individual tax situations and fund performance.

Starting an SWP which is a systematic withdrawal plan from a mutual fund would be a better choice versus an IDCW which means a dividend plan. However, investors comfortable with relying on fund performance for income and willing to accept higher tax liabilities may find IDCW plans appealing. It’s advisable to consult with a financial advisor to determine the most suitable strategy based on your unique financial goals and circumstances.

Dreaming of financial freedom? Use our Online SIP Calculator to see how regular investments can add up to grow wealth. Take the first step towards your goals. Calculate now!

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. The information is based on various secondary sources on the internet and is subject to change. Please consult with a financial expert before making investment decisions.