SWP Vs. IDCW: Choosing the better option for regular income flow

When planning for a steady income, especially post-retirement, choosing the right investment option is crucial. Two popular methods for this purpose are the Systematic Withdrawal Plan (SWP) and the Income Distribution Cum Withdrawal (IDCW).

Let’s take a closer look at the features of SWP and IDCW, understand their key differences, and explore which might be better for your regular income flow.

• Table of contents

1. What is Systematic Withdrawal Plan (SWP)
2. How Does SWP Work?
3. What is Income Distribution Cum Withdrawal (IDCW)
4. How Does IDCW Work?
5. Key factors in choosing between SWP and IDCW
6. Difference between SWP and IDCW for regular income flow

What is Systematic Withdrawal Plan (SWP)

A Systematic Withdrawal Plan, or SWP, allows you to withdraw a fixed amount from your mutual fund investment at regular intervals, such as monthly, quarterly, or annually. This can provide a steady inflow of funds while keeping your investment intact. For example, if you have invested in a mutual fund, you can set up an SWP to withdraw a fixed amount every month. This helps in managing your monthly cash flow.

How does SWP work?

Here are some characteristics of SWP:

1. Initial investment:First, the investor makes an initial investment in a mutual fund. SWPs are commonly used with equity-oriented funds because they offer higher growth potential, but they can work with any fund type.
2. Scheduled withdrawals:The investor selects the frequency (monthly, quarterly, etc.) and the amount they wish to withdraw. For each withdrawal, fund units are sold at the prevailing Net Asset Value (NAV) to generate the requested cash amount.
3. Flexibility:The investor can adjust the withdrawal amount, frequency, or even stop the SWP as per their needs, giving them control over their cash flow.
4. Tax efficiency:Only the capital gains portion of the withdrawn amount (if any) is taxable, so SWPs can be more tax-efficient compared to withdrawing large sums all at once.
5. Growth potential:Since only a small portion of units is redeemed regularly, the balance investment remains in the fund, potentially continuing to grow. This can be more efficient than withdrawing all the money at once.

SWPs are often used by retirees to receive a steady income from their investments without fully redeeming their mutual fund holdings, balancing liquidity with long-term growth potential.

Read Also: SWP for tax efficiency in retirement planning

What is Income Distribution Cum Withdrawal (IDCW)

Income Distribution Cum Withdrawal (IDCW) is another way to receive regular income from your investments. In this method, the mutual fund distributes the profits to the investors as IDCW. The frequency of these IDCW depends on the fund’s performance and the fund manager's decision. It is not fixed, and the amount can vary. Also, the value of investment goes down to the extent of IDCW and taxes, if any.

How does IDCW work?

Here are some characteristics of IDCW:

1. Income distribution: In an IDCW, the fund manager may periodically distribute a portion of the fund's realised profits or distributable surplus (when available) to investors.
2. Non-guaranteed Payouts: Unlike traditional dividends in stocks, IDCW payouts are not guaranteed or fixed. They depend on the fund’s performance, and the amount and frequency of distributions can vary.
3. NAV reduction: After an IDCW payout, the fund's Net Asset Value (NAV) decreases by the distributed amount. This is because the payout is effectively a portion of the investor’s own capital or gains being returned, reducing the NAV and the overall value of their investment in the fund.
4. Tax implications: IDCW distributions are taxable in the hands of the investor as per their applicable tax slab.

IDCW funds can be useful for investors needing some cash flow from their investments, but it’s important to understand that distributions depend on fund performance and reduce the investment value by the payout amount.

Key factors in choosing between SWP and IDCW

When deciding between a Systematic Withdrawal Plan (SWP) and Income Distribution Cum Withdrawal (IDCW) , consider these key factors to determine which option aligns with your financial goals and income needs.

• Consistency of income: SWP provides a fixed amount regularly, while IDCW depends on the fund's performance.
• Taxation: The tax treatment of SWP and IDCW can differ, affecting your net income.
• Investment growth: SWP allows your investment to grow as only a fixed amount is withdrawn. IDCW can reduce your investment base if they are high and frequent.
• Flexibility: SWP offers more flexibility in adjusting withdrawal amounts according to your needs.

Differences between SWP and IDCW for regular income flow

Explore the nuanced differences between SWP and IDCW strategies to determine the optimal choice for your financial goals.

• Income stability: SWP offers a more predictable and stable income as you decide the withdrawal amount. In contrast, IDCW can be irregular as it depends on the fund's profits.
• Taxation: SWP withdrawals are treated as redemption of units, so capital gains tax applies based on how long you have held the investment. IDCW are taxed at the investor's slab rate, which can sometimes be higher.
• Control over investments: With SWP, you have more control over your investments because you can choose the withdrawal amount and frequency. IDCW gives less control as you depend on the fund manager's decision for payouts.
• Impact on investment: SWP can be undertaken on your investment for a longer period if managed well. IDCW might erode your investment quicker if IDCW are substantial and frequent.

Conclusion

Choosing between SWP and IDCW depends on your financial needs and goals. If you prefer a steady and predictable inflow of funds, SWP might be a suitable choice. It offers more control over your withdrawals and can be tailored to meet your monthly cash flow needs. On the other hand, if you are comfortable with variable income, then IDCW could be suitable. However, it is essential to consider the tax implications and how each option affects your overall investment. Before initiating a mutual fund investment, you can also use tools such as SIP lumpsum calculator to enhance your planning process. The tool estimates the potential returns on your investment based on your investment amount, tenure and expected returns. You can use this information to plan or adapt your strategy to align it with your goals. Do note, however, that the calculator's estimates are based on your inputs. Actual returns can vary from your expectations and depend on market conditions.

FAQs

What are the main differences between SWP and IDCW?

The main difference is that SWP provides a fixed, regular income by redeeming units, whereas IDCW gives distribution based on the mutual fund's performance.

How does taxation differ between SWP and IDCW?

SWP withdrawals are subject to capital gains tax based on the holding period, while IDCW are taxed at the investor's income tax slab rate.

Which option is more suitable for retirees looking for a steady income stream?

SWP is generally more suitable for retirees as it offers a predictable and regular income flow.

Can SWP or IDCW be adjusted according to changing financial needs?

SWP can be easily adjusted to increase or decrease the withdrawal amount, providing flexibility according to financial needs. IDCW does not offer such flexibility as it depends on the fund’s performance and manager's decision.

Which is a better option, SWP or IDCW?

SWP is often considered better for those looking for regular, stable income and more control over their withdrawals. IDCW can be suitable for those who prefer variable income and are comfortable with fluctuations. In summary, if you want a regular monthly cash flow, turn to SWP. It provides more stability and control compared to IDCW.

How are SIPs different from SWPs and IDCWs?

Both SWP and IDCW can be used to generate income from your mutual fund investments through withdrawals. On the other hand, SIPs allow you to invest a fixed amount regularly in mutual funds. A variant of an SIP is a step-up SIP, where you can periodically increase your contributions by a fixed rate at regular intervals. An SIP step up calculator can help you visualise the potential returns of such a plan.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.