All You Need to Know About IDCW Option in Mutual Funds

Aug 03, 2023 / Reading Time: Approx. 10 mins

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All You Need to Know About IDCW Option in Mutual Funds

If you are an investor planning to invest in mutual funds or have already invested in the same, you may have several questions crossing your mind regarding the Growth vs IDCW option or 'Income distribution cum capital withdrawal' (IDCW) plans.

Let us understand in detail about the Growth vs IDCW option in Mutual Funds:

There are two alternatives in mutual funds returns disbursement - Growth and IDCW (Income Distribution cum Capital Withdrawal).

The growth plan offers the benefit of compounding as earnings are reinvested into the scheme and is appropriate for investors searching for long-term wealth planning. Mutual fund schemes, on the other hand, share income on stock investments and gains from the sale of underlying equities from the portfolio of the plan. Such a mutual fund scheme's income distribution is referred to as a withdrawal of capital; they are called 'Income Distribution cum Capital Withdrawal' or IDCW plan. Investors looking for regular payouts on their investments may consider IDCW in mutual funds.

[Read: Planning to Invest in the Best Mutual Funds for the Long Term? Read This…]

Growth vs IDCW option in mutual funds: Which is better?

Investors frequently become perplexed about these two possibilities, especially novice mutual fund investors. These are the two categories in which mutual fund plans can be categorised broadly. This article will help you comprehend the difference between the two option plans and how the IDCW option works in mutual funds. So that the next time you pick a mutual fund for investment, you know which one to choose for your investment portfolio.

Growth option IDCW option
Net Asset Value (NAV) The NAV is high compared to the IDCW plan. Since, the reinvested profit can increase in value over time. The NAV is low compared to the growth plan, as dividends are paid from the NAV.
Gains/Profits Reinvested in the scheme Paid out to the investors
Total returns Since the plan focuses on long-term wealth creation, the returns are high as compared to the IDCW plan Due to the periodic dividend payouts, the returns are low compared to the growth option.
Tax implications STCG or LTCG will be applicable as per the investment tenure. Dividend income is taxed as per the investor's income tax slab. However, the normal rate of TDS is applicable at 10% on dividend income paid in excess of Rs 5,000 from a company or mutual fund.
Suitability For investors, seeking long-term capital appreciation For investors, seeking an investment option that pays profits at regular intervals.
 

However, the suitable one between growth or IDCW option in mutual funds depends on the investors' investment needs.

Is it possible to switch from the IDCW option to the Growth option, or vice versa?

In the context of Mutual Fund investments, switching your investments from one option to another within the same scheme is considered as a sale (redemption).

You can switch from the IDCW plan to the growth plan or vice versa, but doing so will be seen as buying the other plan and redeeming the first. Therefore, if there are any exit loads, they will be assessed together with any tax repercussions. As a result, depending on how long you invested, the switch may be subject to exit load and capital gains tax.

Therefore, before switching from one plan to another, make sure, you evaluate the overall benefit of the same.

You may also check out the article below, in which we have highlighted 'How does IDCW option in mutual funds work?' and 'How to choose between growth and IDCW option in mutual funds?'

 

IDCW Mutual Funds: What You Need to Know

Investing in mutual funds require investors to be aware of its terminology and any regulatory changes introduced by regulatory agencies to make informed and worthy investment decisions.

Recently, as I was discussing mutual funds with my friend Aruna, she said, "Investment in mutual funds can sometimes feel like selecting the correct option from multiple-choice questions. As various mutual fund schemes involve plans and options such as - regular plan or direct plan, growth option or IDCW option."

If you have already been investing in mutual funds, then you must be familiar with the available growth or dividend option to select from your mutual fund investments. The investment portfolio of both the dividend plan and growth plan is exactly the same; the difference is in how the returns earned by the scheme are used in both these plans.

For instance, in the dividend plan, you can opt to receive the returns from your investments at a regular interval. If you own 10,000 units of a mutual fund scheme and the current NAV (cum dividend) of the scheme is Rs 100, your total investment value is Rs 10 lacs. Assuming the scheme declares a dividend of Rs 5 per unit, you will get Rs. 50,000 as dividend in that scheme (Total dividend received= no. of units x Dividend per unit).

However, if you've noticed recently, there is no dividend option available anymore. Now, you have the 'IDCW' option. Even though you are an old or new mutual fund investor, chances are you're wondering what is IDCW in mutual funds.

What is IDCW option in mutual funds?

The full form in mutual funds for IDCW is "Income Distribution cum Capital Withdrawal." The dividend option in a mutual fund is now known as IDCW. In this option, 'dividends' are declared periodically from the gains made by the mutual fund and paid out to investors, as dividends, at pre-decided intervals. Dividend payment frequencies can be daily, monthly, quarterly, or annually. This dividend payment is required to be dispatched to unitholders within 15 days from the record date according to the SEBI (Mutual Funds) Regulations, 1996 (Last amended on November 9, 2021).

'IDCW' is an abbreviation of 'Income Distribution cum Capital Withdrawal'. Investing in dividend options means that the investor will receive dividends for the gain from the underlying mutual fund scheme. In other words, profits from the scheme are reinvested in the scheme and made available to the investors as dividends. Investors can either opt for dividend payout or reinvest. The dividend paid out means payout of declared gains to the investors, and however, the dividend reinvest involves the purchase of additional units to the investors. Dividend distributions can be quarterly, half-yearly, or annually.

Why SEBI renamed Dividend Option as IDCW?

In April 2021, the nomenclature of 'Dividend' has been changed by the Securities and Exchange Board Of India (SEBI). What used to be called 'Dividend' earlier is now called 'distribution'. And the 'Dividend Plan' of a mutual fund scheme is now called the 'Income Distribution cum Capital Withdrawal Plan' or IDCW Plans.

Apart from this, the SEBI has also changed the names of dividend reinvestment options and dividend transfer plans i.e., reinvestment of income distribution and transfer of income distribution and capital withdrawal. As per the SEBI regulations, the fund houses must rename the three dividend plans and communicate to their investors that a portion of their capital can be distributed as dividend. There is no major impact on the investors, it is only the change in terminology that you will notice with the IDCW option next to the mutual fund scheme name in your statement of account (SOA) sent by the fund house.

Given that, the major reason behind the SEBI renaming the Dividend option in mutual funds as IDCW is many investors have misunderstood it as a bonus over and above the returns that their scheme is delivering. This was quite misleading and could affect an investor's investment plan.

In simple words, some investors considered dividend paid by mutual funds similar to dividend gains that an investor receives over and above his investment in stocks. This is not the case in mutual funds, the investor receives profits, known as dividends. Dividends received from mutual funds are not extra income or return over and above the gains investors make on redemption. Mutual fund dividends are in lieu of capital appreciation and the same is paid from investor's capital.

Investors are unaware of the difference between income distribution and capital distributions when it comes to mutual funds. The former indicates an appreciation of NAV, whereas the latter indicates the amount in the investor's capital. There is no gain or additional payout, it's like withdrawing money from your capital.

Therefore, the SEBI has decided to rename its existing dividend plan to "Income distribution cum capital withdrawal" (IDCW) to explain the differences clearly, avoid misconceptions, and promote transparency. The IDCW meaning in mutual funds is the same as what dividend meant before, the name change is solely for clarity. Accordingly, mutual fund houses need to communicate this to investors and include it in their offer documents.

What happens to the NAV of a mutual fund scheme when the dividend is distributed?

A mutual fund's Net Asset Value (NAV) is calculated by dividing the value of the fund's assets by the number of the fund's outstanding shares. When it comes to the dividend paid by mutual funds, the dividend is nothing but a part of the profits or money made by investors. The mutual fund scheme is simply distributing the profits among investors in the form of dividends. And when it distributes profits, the NAV comes down by that extent, clearly showing you have taken money out of your investments.

For instance, you own 1,000 units in a mutual fund with a NAV of Rs 20. Your investment value is worth Rs 20,000. The fund announces a dividend/IDCW of 20% of face value, which is Rs 10, or a payout amount per unit of Rs 2. As you hold 1,000 units, you will receive a dividend amount of Rs 2,000. However, do note that this amount will come straight from the value of your investment. On the record date, the NAV of the fund will drop by Rs 2 to Rs 18. This means that along with receiving Rs 2,000 as dividend/IDCW, your investment value will be worth Rs 2,000 less. This is the reason the NAV of the dividend scheme falls by the extent of dividend paid to investors.

How is IDCW in mutual funds taxed?

The taxation for IDCW Plans in mutual funds has also changed. Until the Union Budget 2020-21, dividends declared by mutual funds were subject to DDT or dividend distribution tax, where the fund house deducts the tax on your behalf and transfers the dividend net of tax to you. While the amount was not taxed in your hands, you still bore the impact indirectly as the payout of the DDT would have the effect of reducing the NAV.

However, post the changes announced in the Union Budget 2020-21, dividends or IDCW in mutual funds are taxable at the hands of the unitholder based on the income tax slab rate applicable to them. If you fall under the 30% tax bracket, you will have to pay tax at 30% on the IDCW amount regardless of how long you have been investing in the fund. This robs you of the tax efficiency that funds otherwise offer, and this exhibits a disadvantage the IDCW option carries for investors.

Should investors opt for the IDCW option or the Growth option?

Investors have the choice between Growth or IDCW when deciding returns on investment through mutual funds. The IDCW option in mutual funds offers investors the benefit to withdraw profits earned by a mutual fund, as dividends, at pre-decided intervals. Whereas, the growth option is like a cumulative option. The profits made by the scheme are not paid by way of dividends. Instead, these get accumulated and form part of the scheme via reinvestment. So, whenever the scheme makes a profit, its NAV rises automatically. Conversely, when the scheme suffers a loss, the NAV falls.

Both these option have their individual aspects, investors need to choose based on their suitability and investment objectives. Investors may consider the IDCW option in mutual funds, the downside to regular pay out is losing out on compounding gains. Moreover, IDCW mutual funds will be beneficial only if the market is performing well at that time. If it is low, the investors will lose out on the pay out. If the investor can hold on to the investment amount for a long time, the growth option is preferable. The long-term growth of NAV allows investors to create wealth and achieve long-term goals.

Furthermore, the tax rules are separate for Growth and IDCW option. Capital gain rules apply to growth mutual fund schemes, but IDCW income is added to investors' taxable income and is subject to their normal slab rates. Thus, IDCW mutual fund investors should be able to stomach that risk and be aware of the tax liability.

Therefore, it would make more sense to opt for the growth option and let the capital gains alone be taxed. For equity-oriented funds, long-term capital gains up to Rs 1 lakh are exempt from taxation, and you will have to pay a far lower 10% tax on the remaining. This is more advantageous as against paying tax on the entire IDCW (dividend) amount, which includes both income and capital components.

To Conclude...

Whether to go for a dividend option or growth option solely depends on your needs, investors must assess their risk profile, investment horizon, and goals before investing in mutual funds via either of the options.

The dividend option works best when markets are at an all-time high. As the NAV of the fund rises consistently, the likelihood of fund declaring dividends is higher. Moreover, if you are dependent on your investments for a regular income, the dividend option might work for you. This is suitable for investors close to or in the phase of retirement seeking for a regular income source.

However, if you aim for wealth accumulation, you may consider the growth option. The growth option can be suitable for investors having a long-term investment horizon and focused on wealth creation. It will help them in accumulating corpus for retirement as well. Moreover, in case you earn a regular income and aren't in need of dividends, go for growth option.

As you can tell, the primary difference between the IDCW and growth option is that of profit payout. Investors must choose the suitable Growth or IDCW option by investing in a worthy mutual fund scheme that leads to generating significant returns and enhances the performance of your investment portfolio.

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MITALI DHOKE is a Research Analyst at PersonalFN. She is an MBA (Finance) and a post-graduate in commerce (M. Com). She focuses primarily on covering articles around mutual funds including NFOs, financial planning and fixed-income products. Mitali holds an overall experience of 4 years in the financial services industry.
She also actively contributes towards content creation for PersonalFN’s social media platforms in the endeavour to educate investors and enhance their financial knowledge.

 


Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.

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