IDCW vs SWP: which of these options should retirees choose and why

Summary

IDCW payouts from mutual funds are neither guaranteed nor necessarily tax-efficient. For retirees seeking regular cash flows, a disciplined SWP can offer greater control over withdrawals and taxation.

Recently, at dinner, I met individuals in their 50s, nearing retirement, and those who had already hung up their work boots. The hot topic was the rising cost of living and how to meet cash-flow needs during the golden years.

While most had built a sizeable corpus by investing in equity mutual funds over the years, some, particularly those in their 60s, had chosen the ‘Income Distribution cum Capital Withdrawal’ or IDCW option (erstwhile referred to as the dividend option), hoping to earn regular income to meet retirement expenses.

I was surprised by this and explained why this may not be a definitive way to address cash-flow needs.

IDCW myths

The fact is, IDCW payouts are not guaranteed, unlike interest-earning fixed-income instruments, and are often at the discretion of the mutual fund house and fund manager.

As per Sebi regulations, the scheme needs to generate a distributable surplus to declare an IDCW payout. Even if there is a distributable surplus, it does not obligate the fund manager to declare and give the payout.

In challenging years, if the scheme has not fared well, the fund may not announce an IDCW payout. Even if you have invested in a scheme under the “monthly IDCW” option, it only indicates the frequency at which the fund house reviews the scheme for potential distribution; it does not guarantee regular monthly payouts.

So, the IDCW option is not a sure-shot way of expecting regular and predictable cash flows during retirement.

It is also incorrect to assume that, like dividend yield in stocks, IDCW payouts in mutual funds work the same way. That is completely untrue. The IDCW payout comes from accumulated profits or the investors’ investment value, unlike stocks, where the company distributes profits by way of dividends to shareholders.

After the abolition of the Dividend Distribution Tax (DDT), IDCW payouts are taxed as ‘income from other sources’ as per your income-tax slab.