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IDCW Plans in Mutual Funds And Their Impact On Your Investments

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Over the past few months, mutual fund investors, especially those who have invested in Dividend Plans, may have come across a new term called IDCW or Income Distribution cum Capital Withdrawal. In fact, investors have received a notification from their asset management company in April 2021, conveying an alteration in terminology when SEBI revised ‘Dividend Option’ to IDCW in a mutual fund. 

Let’s first understand what dividend plans are and how different they are from growth plans. 

What Are Dividend Plans in Mutual Funds?

Dividend plans are mutual funds that invest your wealth in stocks that pay dividends. Moreover, investors can use their dividends as an income stream or re-invest the same to purchase more units of funds. 

Contrary to popular belief, a dividend is not the same in mutual funds and stocks. For instance, when a company declares a dividend payout, it distributes profits among the investors in its stock. Here, this dividend is the additional returns that investors make on the stock’s price appreciation. 

In mutual funds, a dividend is a portion of the profits made by investors. A mutual fund simply distributes this profit among investors. Additionally, when profit distribution takes place, its NAV drops by that extent, implying that investors have taken money out of their investments.

Also Read: Difference Between SIP and Mutual Funds

SEBI’s New Rule on Dividend Plans

As mentioned earlier, the Securities Exchange Board of India changed the term ‘Dividend Option’ in April 2021, thereby renaming it to ‘Income Distribution cum Capital Withdrawal’ or IDCW. 

So, if you currently invest in a mutual fund offering dividend returns, you will notice the term ‘IDCW’ beside the scheme name on your statement of account (SOA) as provided by your asset management company. That said, as an investor, you must know that this is a mere terminology revision, and does not impact your investment.

Also Read: Easy Ways to Invest in Mutual Funds Online

Why Has SEBI Renamed Dividend Plan as IDCW Plan?

In order to understand why SEBI introduced this change, you need to understand the backdrop. Firstly, investors seeking a steady income from their investments often turned to dividend plans as they provided an easy way to get regular. However, they failed to realise that by doing so, they were essentially pulling out the profits from their investments. And over a long period, this will lead to a small corpus.

In addition, most investors generally associate ‘dividends’ with the stock market. Therefore, investment advisors suggest that dividend plans were a misnomer in the case of mutual funds

So, SEBI brought about this change as the term IDCW depicts dividends in mutual funds more accurately. As a result, the regulatory body ensured that there were no misconceptions regarding mutual fund dividends among investors. 

How Does Dividend Distribution Work in Mutual Funds? 

Let us elaborate on the inner workings of dividend distribution in mutual funds by way of an example:

Suppose an investor owns 1,000 units of a mutual fund scheme. Moreover, its current NAV (cum dividend) is Rs. 100. This scheme also declares a dividend worth Rs. 10 per unit. 

So, this impacts the investment in the following way:

NAV Rs. 100
Total Number of Units1,000 units
Total Investment ValueRs. 1,00,000
Per Unit DividendRs. 10 
Ex Dividend NAVRs. 90
Investment Value Post Dividend PayoutRs. 90,000

The above example illustrates that dividends come out of your investment value. If you opt for this option, you will receive these dividends directly from your asset management company. 

In fact, it must dispatch the dividend warrants to unitholders within a period of 30 days after dividend declaration, failing which it shall be liable to pay a delay interest of 15% (this rate is subject to change by SEBI). 

Also Read: Active Mutual Fund Vs Index Mutual Fund: Which One Should You Opt For

Common Misconceptions About Mutual Fund Dividends in India

Now that you have a fundamental understanding of IDCW in mutual funds, allow us to burst some of its common misconceptions in India:

Misconception 1: Dividend options book profits on a regular basis.

Reality: The underlying portfolios for all mutual funds remain the same. Thus, when the fund manager books profits, they remain the same. However, the two options have different distribution methods. For the dividend option or IDCW, a part of the profits is given to investors, while for the growth option, these are reinvested into the scheme.

Misconception 2: Dividends paid by a mutual fund scheme is paid by its underlying stocks

Reality: Dividend payouts may include those received from a portfolio’s underlying stocks, in addition to profits earned on the sale of stocks in the scheme.

Misconception 3: Dividends from mutual funds are an additional income that is over and above capital appreciation.

Reality: Dividends in mutual funds are not extra returns, as highlighted in the example discussed earlier. 

Dividends Declared by Companies and Mutual Funds: Differences 

The table below points out the differences between the two dividend options:

Basis of DifferentiationCompanies Declaring DividendsMutual Funds Paying Dividends
Payment of DividendsDividends are paid by companies from their profit after tax or PAT after they retain a portion of it under Reserve and Surplus for the firm’s growth in the future.Mutual fund schemes pay dividends from their accumulated profits.
AuthorisationA company’s management decides upon the portion of profits to be paid out to shareholders as dividends.An asset management company (AMC) decides upon this dividend payout and its rate/unit.
Impact of the PaymentA company’s shares may go up or down.A scheme’s NAV goes down.

Should You Invest in IDCW or Growth Plans? 

To arrive at a decision, we suggest that you consider the following points:

  • Profits schemes stay invested in the same growth option. So, you can earn profits on profits over long investment tenures. In IDCW mutual funds, profits are distributed fully or partially, thereby eliminating the compounding advantage.
  • The growth option is suitable for investors seeking wealth creation or capital appreciation. IDCW is well-suited for those requiring interrupted cash flows. 
  • Long-term capital gains (LTCG) from equity funds get tax exemption of up to Rs. 100,000 while LTCG from debt funds has indexation benefits. No such tax benefits are available for investors in case of income from IDCW.  
  • Dividends received in IDCW are added to an investor’s taxable income and taxed as per his/her tax slab.

Final Word

SEBI’s alternation in terminology is aimed at eliminating any misconception regarding IDCW in mutual funds. Moreover, it is suitable for you if you wish to derive consistent income from your investment. That said, remember that there are no guaranteed returns from mutual funds. 

Considering investing in mutual funds? Download the Navi app and get access to a host of Navi Mutual Fund schemes. You can start small with a nominal amount of Rs. 500 or go for lump sum investments at your convenience.

Frequently Asked Questions

Is IDCW taxable in India?

Yes, returns are added to your income and taxed according to your tax slab.

Which is better- IDCW or growth?

There is no better alternative as each option caters to varying investment objectives. 

What taxes are applicable for income received from IDCW?

Income from the IDCW option in a mutual fund gets added to one’s taxable income and is then taxed as per his/her income tax slab. If the dividend amount crosses Rs. 5,000, a certain TDS is also applicable.

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