SWP vs Dividend Option: Which is Tax-Efficient?
Compare Systematic Withdrawal Plans (SWP) with dividend payout options for generating regular income from mutual funds. Learn which option saves more on taxes.
You want regular income from your mutual fund investments. Two options exist: Systematic Withdrawal Plan (SWP) from growth funds or Dividend payout option.
Which is more tax-efficient? The answer has changed significantly after 2020 tax rules. Let's break it down.
Quick Answer: SWP Usually Wins
| Factor | SWP (Growth) | Dividend |
|---|---|---|
| Tax rate | Capital gains (12.5% LTCG) | At your slab rate (up to 30%) |
| Tax timing | Only on gains | On entire dividend |
| Corpus growth | Tax-free until withdrawal | Already taxed at source |
| Control | You decide amount | Fund house decides |
| Flexibility | Adjust anytime | Dependent on fund |
For most investors, SWP is more tax-efficient.
How Dividend Taxation Changed (2020)
Before April 2020 (DDT System)
- Dividend Distribution Tax (DDT) paid by fund house
- Dividend tax-free in investor's hands
- Effective tax: ~11.6% for equity, ~29.1% for debt
After April 2020 (Current Rules)
- No DDT
- Dividend taxed at investor's slab rate
- TDS at 10% if dividend > ₹5,000/year
This change made dividends much more expensive for high-income investors.
Tax Comparison: SWP vs Dividend
For Equity Funds
Scenario: ₹1 lakh income needed, corpus of ₹20 lakh (50% gain portion)
| Method | Tax Calculation | Tax Paid |
|---|---|---|
| Dividend | ₹1,00,000 × 30% | ₹30,000 |
| SWP | ₹50,000 gain × 12.5% | ₹6,250 |
SWP saves ₹23,750 (assuming 30% bracket)
Why SWP wins:
- Only gain portion is taxed (not principal return)
- LTCG rate is 12.5% (not your slab rate)
- ₹1.25 lakh annual LTCG exemption further reduces tax
For Debt Funds (Post-2023 Rules)
Scenario: ₹1 lakh income needed, corpus of ₹20 lakh (40% gain portion)
| Method | Tax Calculation | Tax Paid |
|---|---|---|
| Dividend | ₹1,00,000 × 30% | ₹30,000 |
| SWP | ₹40,000 gain × 30% | ₹12,000 |
SWP saves ₹18,000 (assuming 30% bracket)
Post-April 2023, debt fund gains are taxed at slab rate (no indexation benefit). But SWP still wins because only the gain portion is taxed.
Calculate your SWP: Use our SWP Calculator to plan tax-efficient withdrawals.
The Math: Why SWP is Tax-Efficient
Concept: Principal vs Gains
When you withdraw via SWP, part of it is your principal (already taxed when you earned it) and part is gains (taxable).
| Your Withdrawal | Principal Portion | Gain Portion | Taxable |
|---|---|---|---|
| ₹10,000 | ₹6,000 | ₹4,000 | ₹4,000 only |
With dividend, the entire amount is taxable as income.
Example Over 5 Years
Initial: ₹20 lakh invested, grown to ₹30 lakh (50% gain) Need: ₹50,000/month income
| Year | SWP Withdrawal | Principal Return | Gain | Tax (30%) |
|---|---|---|---|---|
| 1 | ₹6,00,000 | ₹4,00,000 | ₹2,00,000 | ₹18,750* |
| 2 | ₹6,00,000 | ₹4,00,000 | ₹2,00,000 | ₹18,750 |
| 3 | ₹6,00,000 | ₹4,00,000 | ₹2,00,000 | ₹18,750 |
| Total | ₹18,00,000 | ₹12,00,000 | ₹6,00,000 | ₹56,250 |
*After ₹1.25 lakh exemption, tax is: (₹2L - ₹1.25L) × 12.5% = ₹9,375 in year 1
If same ₹6 L was received as dividend: Tax = ₹6,00,000 × 30% = ₹1,80,000/year
SWP saves ₹1.24 lakh per year!
When Dividend Might Work
1. You're in 0-5% Tax Bracket
If your total income (including dividends) is below ₹5 lakh, dividend taxation is minimal.
| Income Level | Dividend Tax | SWP Tax |
|---|---|---|
| Below ₹2.5 L | 0% | 0% (exempt gains) |
| ₹2.5-5 L | 5% | 12.5% LTCG |
| Above ₹5 L | 20-30% | 12.5% LTCG |
For very low income, dividend and SWP are similar.
2. You Need Irregular Income
Dividends come when the fund declares them—unpredictable timing and amount. If you don't mind irregularity, dividend is simpler (no setup required).
3. Fund Doesn't Support SWP
Some funds or platforms don't offer SWP facility. In that case, dividend is your only option for regular income.
Practical Considerations
Setting Up SWP
- Choose growth option when investing (not dividend)
- Wait for 1+ year holding (for LTCG benefit on equity)
- Set up SWP via AMC website or app
- Specify amount and frequency (monthly, quarterly)
- Link bank account for direct credit
Managing LTCG Exemption
You get ₹1.25 lakh LTCG exemption annually. Strategy:
| Your LTCG | Action |
|---|---|
| < ₹1.25 L | No tax—enjoy full exemption |
| ₹1.25-2.5 L | Some tax, still efficient |
| > ₹2.5 L | Consider spreading across years |
Tip: If withdrawing large amount, split across two financial years to use exemption twice.
Tracking Cost Basis
SWP requires knowing your purchase price to calculate gains. Options:
- FIFO method (First In, First Out)—oldest units redeemed first
- Consolidated Account Statement (CAS)—shows unit-wise details
- AMC website—shows gain/loss on redemption
Most AMCs automatically calculate tax when you withdraw.
Tax on SWP: Step-by-Step
Equity Fund SWP (Held > 1 Year)
| Component | Tax Treatment |
|---|---|
| Principal returned | No tax |
| STCG (< 1 year holding) | 20% |
| LTCG (> 1 year holding) | 12.5% above ₹1.25 L |
Debt Fund SWP (Post-April 2023)
| Component | Tax Treatment |
|---|---|
| Principal returned | No tax |
| Gains (any holding period) | At slab rate |
No more LTCG benefit for debt funds—but SWP still beats dividend.
Hybrid Fund SWP
Treated as equity if 65%+ in equity, else as debt.
Common Mistakes
1. Choosing Dividend for "Regular Income"
Dividends are not guaranteed. Fund may skip or reduce dividends. SWP gives you controlled, predictable income.
2. Not Considering Exit Load
Some funds have exit load on redemption. Factor this into SWP calculations.
| Fund Type | Typical Exit Load |
|---|---|
| Equity (< 1 year) | 1% |
| Debt (< 1-6 months) | 0.5-1% |
| Liquid | Nil after 7 days |
3. Withdrawing Too Much
SWP at 8-10%+ annual rate depletes corpus quickly. Sustainable rate is 4-5%.
4. Wrong Fund Type for SWP
Don't set up SWP on volatile small-cap funds. Use:
- Balanced Advantage funds
- Large-cap funds
- Debt funds (for stability)
Verdict by Investor Profile
| Profile | Recommendation |
|---|---|
| Salaried (20-30% bracket) | SWP—saves significant tax |
| Retired (low income) | Either—minimal difference |
| Business owner (30%+ bracket) | SWP—maximum tax savings |
| NRI | Depends on country—consult advisor |
Switching from Dividend to Growth
If you're currently in dividend option:
- Check exit load (usually nil for older investments)
- Switch to growth (treated as redemption + new purchase)
- Tax impact: LTCG/STCG on gains in dividend option
- Set up SWP after switch
Timing: Switch when gains are minimal to reduce tax impact.
Conclusion
SWP beats dividends for most investors because:
- Only gains are taxed (not entire withdrawal)
- LTCG rate (12.5%) < slab rate (up to 30%)
- ₹1.25 lakh annual exemption
- You control timing and amount
- Corpus continues growing tax-free
The 2020 tax change made dividends expensive. Unless you're in the lowest tax bracket, SWP is the clear winner for tax-efficient regular income.
Plan your regular income: Use our SWP Calculator to see how long your corpus lasts with tax-efficient withdrawals.