In my previous post, i was explaining the changes in Taxation of Dividends from your Investments and the details of it. In the post we saw the tax to be paid under Dividend option, TDS process etc. Please read (http://www.fundwallet.in/to-be-or-not-to-be/) know more on that.
I was mentioning that it’s beneficial to be in Growth option irrespective of your tax structure, we will see the details of it now. If you are someone who has invested in Dividend option to get regular payouts by seeing the past Dividend Track record, please be aware that the Dividends are no guarantee; it’s advisable to invest in Fixed Income generating instruments for this need.
In the dividend option the entire amount is taxed and with the new rule and if you are in higher tax slab you need to shell out more money as tax. If you need regular payouts, and you are ready for the Mutual fund investment, instead of Dividend Option, you can use the Systematic Withdrawal Option (SWP) in Mutual Funds. There are two advantages to this; one is you will pay less tax and the other is you have potential to get higher returns.
Under the Dividend option, you need to pay tax on the entire amount received by you, whereas if you use SWP, you need to pay tax only on the gain. For example:
Imagine you invest Rs.10 lakhs in a debt mutual fund under dividend option. For the ease of calculation let’s assume that the NAV was Rs.10, and you were allotted 1 lakh units (10 lakhs investment amount divided by NAV of 10).
Now, suppose the NAV goes up to 11 rupees in a year’s time and the fund decided to declare the entire appreciation as dividend. So you will receive 1 lakh as dividend (1lakh units * 1 rupee) and immediately the NAV will go to Rs. 10.
You will receive the entire amount within 30 working days (now dividends are credited through electronic mode, so you will receive in less than 10 working days). From this you will have to pay 30% 20% or 10% depending on your tax slab less TDS while filing your IT returns. The amount of tax comes to 30,000 or 20,000 or 10,000.
Instead, if you had opted for SWP of 1 lakh, for this, the MF will take 9091 units at 11 NAV and then credit the amount to you. You derive the units by dividing the withdrawal amount by the prevailing NAV so (100000/11=9091 units). And your tax liability would have been lower, not on the percentage terms, because being a debt fund, both dividend income and capital gain is taxed at your tax slab, but you will pay lesser amount.
Though you withdrew 1 lakh, your capital gain will be just Rs. 9091. That is, 9,091 units sold multiplied by Re.1 the actual gain in NAV (11 minus 10). On this gain you need to pay 31.2% (tax+surcharge+cess) so the tax amount comes to just Rs. 2836. Imagine the difference; this is very much less than Rs. 30000 as dividend tax. If you withdraw after 3 years, you can apply indexation and the benefits you derive will me much much more.
Again, under SWP option you can decide on the withdrawal amount based on your requirement, but that is not the case with dividends, the Mutual fund Company will decide the amount and if you receive less then you need to find alternate source, if you receive more then you will spend for some unwanted things.
The other advantage is, by paying less tax and getting the required amount you are letting the funds invested, which will definitively yield you higher returns. Assume that Fund A gives a return of 10%, if you are in Dividend option, you get money to your bank account and that goes burst or you are invested in Reinvest option, here the dividend amount gets re-invested after deducting the necessary tax, where as in Growth Option you withdraw what is required and keep the balance money invested, and take the benefit of compounding.
Investing in growth option and withdrawing through SWP benefits you by less taxation and more growth of capital.
Happy Investing
RaVi
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