IDCW in mutual fund: What it is and How does it works
In India, mutual fund houses have many types of mutual fund schemes. The two major types of mutual fund schemes are growth investment and dividend option mutual fund schemes. In growth investment, the mutual fund scheme reinvests one portion of the profit into the investor’s entire investment. In April 2021, SEBI changed the term ‘dividend option’ to an ‘IDCW’ (Income Distribution cum Capital Withdrawal). Do you know what is IDCW in mutual fund?
IDCW is income distribution to investors in IDCW mutual fund schemes. But before the name change of IDCW, the people misunderstood dividend payout as additional income. But it is not; this IDCW payout only comes from investors’ investments.
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What is IDCW in Mutual Fund
The IDCW full form Income Distribution cum Capital Withdrawal is the new rule of SEBI in the dividend plan for mutual fund schemes. The words used IDCW or distribution of income instead of ‘dividend’.
For example, investor’s total investment is Rs. 50,000, and he holds 500 units of stocks, the IDCW in the mutual fund scheme declares the distribution income rate or dividend rate is Rs.2. Then the investor receives the income of Rs.1000. And the entire investment will become Rs.49000.
Particulars | Amount |
---|---|
Number of units | 500 |
NAV | 100 |
Investment value | 50000 |
Dividend per unit | 2 |
Total dividend received (no. of units x Dividend per unit) | 1000 |
Dividend after IDCW payout | 98 |
total investment value after IDCW Payout | 49000(98*500 units) |
How IDCW payout works in mutual fund
The term ‘Dividend Plan’ only change to IDCW; there are no added benefits here. In this IDCW in a mutual fund scheme, if you are not compounding your returns, you are not earning expected returns. And it has some tax disadvantages.
Let’s see the example for IDCW in a mutual fund schemes, and growth plan mutual fund schemes. Here, both mutual fund schemes have the same investment amount. And the Net Asset Value is Rs.10. Investors holding units are 5000. The dividend distribution declares Rs. 2.
Particulars | IDCW Mutual Fund Scheme | Growth Plan Mutual Fund Scheme |
---|---|---|
Opening Investment amount | 50,000 | 50,000 |
Net Asset value | 10 | 10 |
Holding units | 5000 | 5000 |
Distribution(dividend) Declares | 2 | NIL |
IDCW payout amount | 10,000 | NIL |
NAV after IDCW payout | 8(10-2) | 10 |
NAV at the end of the year | 9 | 13 |
total investment value | 45000(9*5000 units) | 65000 |
When you receive 10,000 as an IDCW payout, your total investment amount will reduce at the end of the year as per NAV value is 45000 from 50000. In the growth plan, you invested the same amount of 50000. The total investment will increase as per NAV value at the end of the year.
Also Read: What are the Functions of Mutual Funds
Taxability of IDCW Schemes in Mutual Fund
Since Finance Act 2020, tax payment has been mandatory for all IDCW payouts. Before Finance Act 2020, the company must pay 15% of the Distribution Dividend Tax. In a financial year, if the income of IDCW payout is above one lakh, they have to pay tax.
Otherwise, if the payment of IDCW payout is below one lakh, they need not pay tax. And also, note the important point that as per the TDS (Tax Detection Source), the Asset Management Company (AMC) deducted only the tax for above 5000 of income.
Which Mutual Fund Schemes are more suitable? IDCW or Growth?
In India, investors can invest in growth mutual fund schemes or IDCW in mutual fund schemes. You can invest in growth mutual fund schemes if you expect long-term growth. If you wish for a fixed income with minimum stable returns, you can invest in IDCW mutual fund schemes.
In growth mutual fund schemes, you have to pay two types of taxes, that is
1. Long Term Capital Gains (LTCG)
2. Short Term Capital Gains (STCG)
For IDCW in a mutual fund schemes, you must pay three types of taxes. that is
- Tax for income of IDCW payouts
- Long Term Capital Gains (LTCG)
- Short Term Capital Gains (STCG)
Though which mutual you choose, you have to analyze before investing. There are regular withdrawals not allowed in growth mutual fund schemes.
Generally, before your mutual funds are mature, if you withdraw the fund in a short period, there is no use, and your mutual fund scheme needs to be revised. However, it doesn’t mean staying in worse mutual fund schemes.
Also Read: Top 9 Benefits of Mutual Funds: Complete Guide
Misunderstandings about Mutual Fund Dividends in India
1. Some wrongly assume that mutual fund schemes pay dividends from the scheme portfolio’s underlying stocks. Mutual fund dividends may also include gains realized by selling stocks in the scheme portfolio holding.
2. Some investors think mutual fund dividends are additional income or return above capital appreciation. However, dividends received from mutual funds are not extra income but a distribution of the capital appreciation, which means that mutual fund dividends are paid from the investor’s capital and are not in addition to the gains earned upon redemption.
Consequently, the NAV of the dividend scheme lowers by the portion of the dividend disbursed to investors.
3. A misconception exists that mutual fund schemes’ dividend options regularly book profits to pay dividends. However, the underlying portfolio scheme, income of IDCW payout, or any alternatives of a mutual fund scheme is similar. When the fund manager books a profit, it occurs at the scheme level for all the options.
The difference lies in the distribution of the scheme profits. In the growth option, the profits are reinvested in the scheme and reflected in the NAV of the growth option. In contrast, in the dividend option (IDCW), a portion of the profit may distribute to investors at the fund manager/AMC’s discretion. It is important to remember that the distribution of scheme profit is not compulsory for the AMC to pay to investors in the dividend option.
Conclusion
Although the income distribution from these mutual funds may be insignificant, you must notice this. Investors seeking regular income from mutual fund investments may find IDCW (Income Distribution cum Capital Withdrawal) options suitable. Retired investors seeking stable cash flows may opt for IDCW, knowing that the income distribution is solely at the discretion of the fund manager or AMC.
It is important to note that IDCW payouts in mutual funds rely on the actions of the underlying companies and market movements, and regular payouts are not guaranteed.
Moreover, investors with low-risk tolerance may prefer to invest in IDCW mutual funds as they seek stable returns. During bear market phases, these funds may provide some dividends to investors.