When you invest in a Mutual Fund plan, you are always given two alternatives. One, you can allow the scheme’s returns to be reinvested. Two, you can choose to get your investment returns on a regular basis. The first is known as the Growth Option of a Mutual Fund scheme, while the second is known as the ‘Income Distribution and Capital Withdrawal’ plans, or IDCW Mutual Fund (Earlier known as Dividend Plans).
As a result, investors that want a consistent income from their mutual funds typically pick the IDCW Plan. The Growth Plan, on the other hand, is chosen by investors who wish to profit from long-term wealth appreciation, notably through stock investment, because all fund returns are reinvested.
Aside from these two schemes, there is also one named ‘Reinvestment of IDCW’ (formerly known as the Dividend Reinvestment Plan). This option is not offered in all mutual fund schemes, and only a handful do so. Returns or dividends are announced by a scheme but not paid out to you in this Reinvestment of IDCW plan. Instead, after dividend declaration, the profits are reinvested at the fund’s NAV.
On the surface, the IDCW Reinvestment Plan appears to be identical to the Growth Plan, however, there are significant distinctions in how they operate and are taxed. In this article, we will go through all of the distinctions between the two solutions and determine which one is superior.
What Is An IDCW Mutual Fund?
IDCW Mutual Fund invests in companies that have the ability to pay dividends to their shareholders on a regular basis, such as quarterly or yearly. The IDCW (Income Distribution Cum Capital Withdrawal) fund’s managers strive to invest in dividend-paying firms with a track record of dividend payments. Firms, on the other hand, pay dividends to their shareholders when they make a profit, and these companies are often large cap/blue chip and well-established in the market.
Assume you invested Rs 1,00,000 into a mutual fund scheme with a NAV of Rs 10 per unit. As a result, you will earn 10,000 units.
Assume the mutual fund’s NAV increased to Rs. 16 per unit after a year, and the plan declared a Rs. 2 per unit payout. As a result, your dividends will be Rs. 20,000 (Rs. 10,000*2). And the overall value of the Dividend Reinvestment Plan or IDCW Reinvestment Plan is reduced by the amount of dividends that have been withdrawn. As a result, the NAV of the scheme would fall by Rs. 2 to Rs. 14 from Rs. 16.
This Rs. 20,000 return you got will now be reinvested. The new NAV is Rs 14 per unit, which implies you will receive 1,428.57 units (10,000 / 14). As a result, your total number of units in that scheme will rise to 11,428.57 (10,000 + 1,428.57). And the total investment value will be Rs. 1,60,000 (Rs 14* 11,428.57 units).
Important Points For The IDCW (Dividend) Mutual Fund
- According to SEBI rules, the dividend is paid from the scheme’s earnings.
- The frequency, timing, and amount of dividends are NOT FIXED. As a result, if you want consistent income, dividends may not be a practical choice for you; instead, you can use the SWP option in mutual funds.
- The dividend paid to the investor is deducted from the mutual fund scheme’s NAV (unit price). As a result, the NAV of the MF scheme decreases following dividend payment, but the number of units grows in the case of the dividend reinvestment option.
- The dividend paid to the investor is taxed at the time of payment. Previously, the tax burden was on the company, but now it is on the investors ( as per the investor tax slab rate).
What Is A Growth Mutual Fund?
Growth mutual funds invest in firms with the potential for rapid growth and large profits. The fund’s primary goal is to increase the value of investors’ assets. However, investing in growth funds might be dangerous because these firms are vulnerable to market volatility. Instead of paying out dividends, growth firms reinvest their profits back into the business. As a result, you gain profits on profits, which allows you to reap the benefits of compounding. It is recommended that you invest in a growth mutual fund for 3 to 7 years to enjoy the most rewards. Unless you want consistent cash flow, growth mutual funds are the best alternative.
The fund’s NAV (Net asset value) rises when the fund’s value rises, resulting in an increase in the fund’s portfolio valuation. Capital gains from mutual funds are taxed at different rates. This tax will be paid by investors when they redeem their fund units. However, investors are only required to pay taxes on their earnings.
Important Points For A Growth Mutual Fund
- Due to the fact that investors receive a return on their investment in IDCW options, the Growth fund’s NAV will always be higher than dividend mutual funds.
- The portfolio (where the money in the MF scheme is invested) is the same for growth and dividend MF.
- A growth fund provides a larger overall return on investment ( compounding effect).
- From an investing standpoint, the growth and dividend reinvestment options are identical; however, dividend taxation differs.
Growth Vs IDCW Mutual Funds
|Difference||Growth Plan||IDCW Plan|
|Purpose to invest||Money Appreciation||Income from Money|
|NAV of Fund||The NAV is always greater than the dividend option.||NAV will fall after dividend payment. As a result, NAV decreases after profit payout.|
|Profit of the scheme||Keeping exclusively with the fund results in a growth in NAV and consequently profit.||Profit is provided to the investor on a regular basis.|
|Taxation||There is a short-term or long-term tax. This tax is determined by when you withdraw your money.||Taxed as per income tax slab rate of investor|
|Who should invest||If you want your money to appreciate in value||If you require revenue from your mutual fund investment|
|Which is better||Preferable alternative for money accumulation/growth.||For income dividend option is better|
|Taxation point of view||Growth funds are superior in terms of taxation since they are less taxed.||In terms of taxation, dividend funds are more taxed than growth funds.|
Which Is Better?
The decision between IDCW and growth plans is influenced by the preferences and demands of investors. The only variation between the two alternatives is how the gains are dispersed or reinvested, even though the underlying portfolio stays the same.
The IDCW plan is appropriate for individuals seeking regular income from their assets since it provides some liquidity. The money they invested will be returned to them on a regular basis. Furthermore, dividend income is taxed at the investor’s marginal tax rate. However, investors lose the benefit of compounding under this strategy since a portion of the investment value is not included in future returns.
The growth plan is appropriate for investors who want to expand their money over time. This planprovides the benefit of compounding since gains are reinvested, multiplying and creating wealth. Furthermore, capital gains are taxed based on the kind of fund and the holding term. As a result, while choosing an option, investors must consider the tax consequences as well as the investing aim.
IDCW and Growth Plan Tax Implications
Taxation Under IDCW Plan
Dividends received from mutual funds are taxable in the hands of investors beginning April 1, 2020. Dividend income is classified as income from other sources, and investors pay tax based on their tax slab rate.
As a result, if you are in the 30% tax band, you will pay 30% tax on dividends announced under the IDCW Reinvestment Plan for the fiscal year. As a result, your returns from mutual funds will be reduced even further.
Furthermore, a 10% TDS is levied on dividends paid by Mutual Fund schemes if the payout amount exceeds Rs. 5,000. This implies that in the preceding example, the amount reinvested will be less due to the TDS on mutual fund income. As a result, the eventual value of investments will be reduced.
Only when the dividend announced is less than Rs. 5,000 and your total taxable income is less than Rs. 5 lakh per year will your IDCW Reinvestment Plan returns be the same as the Growth Plan. There will be no TDS and you would not have to pay any tax on your dividend in such instance.
Taxation Under The Growth Plan
This plan’s taxation occurs when the investor redeems the fund units. It also depends on the sort of fund, such as an equity or a debt fund.
Short-term capital gains in equity funds are taxed at 15% if held for less than a year. Long-term capital gains are free from tax up to INR 1 lakh, after which they are taxed at 10% if held for more than a year.
Short-term capital gains in debt funds are taxed at the investor’s income tax bracket rate if held for less than three years. Long-term capital gains are taxed at 20%, with an indexation advantage if held for longer than three years.
IDCW and growth plans are both excellent investment choices. If you want to increase your wealth over time, investing in a growth plan can do the job. And if you want to earn a steady income or passive income, an IDCW plan is appropriate for you. Furthermore, you should select a mutual fund scheme depending on your needs, risk tolerance, and financial objectives. In addition, before deciding between IDCW and growth mutual funds, you should grasp the fundamentals of the stock market, the many types of mutual fund schemes, IDCW, and growth differences in order to make an educated selection.
This is not an investment recommendation. The blog is just for informational purposes. Investments in the securities market are subject to market risks; before investing, thoroughly read all relevant documentation. Past performance does not predict future results. Before selecting a fund or constructing a portfolio that meets your needs, please evaluate your unique investing criteria, risk tolerance, aim, time frame, risk and reward balance, and the cost of the investment. Any investment portfolio’s performance and returns cannot be anticipated or guaranteed.
Which Is Better, IDCW Or Growth?
IDCW and growth mutual funds both provide inflation-beating returns and can assist you in meeting your financial objectives. The main difference is that IDCW plans deliver earned income to investors on a regular basis, whereas growth mutual funds reinvest their earnings.
What Is The Distinction Between The Growth And Dividend Reinvestment Options?
The dividend is reinvested back into the fund via growth funds. As a result, it provides long-term compounding advantages. Dividend reinvestment options, on the other hand, employ the received dividend to purchase further units of the fund on the investor’s behalf. As a result, the number of units grows.
What Factors Should Investors Examine When Transitioning From A Dividend Plan To Growth Plan?
Switching your mutual fund investments from one option to another within the same scheme is termed a sale (redemption). As a result, depending on how long you invested, the switch will incur an exit burden and capital gains tax.
The two schemes’ options have different NAVs and work in distinct ways.
- The growth option reinvests fund gains, allowing you to benefit from the power of compounding and is better suited for long-term wealth accumulation.
- The dividend option distributes the fund’s earnings to its investors. This option is only appropriate for people who want to earn a consistent income from their Mutual Fund investments.
Why Did SEBI Changed Dividend To IDCW?
Income Distribution cum Capital Withdrawal or IDCW, refers to a mutual fund scheme’s distribution of income, which may comprise both dividends paid by stocks and capital gains achieved by selling underlying equities from the scheme portfolio. However, SEBI wants to underline that this income is derived solely from the investor’s investment value. In other terms, it is a capital withdrawal. According to SEBI, the term IDCW is a more appropriate definition of mutual fund dividends, and investors should have no misconceptions regarding mutual fund payouts.
Is There A Difference Between Dividends Declared By Mutual Funds And Dividends Announced By Companies?
Even while dividends paid by mutual fund schemes may appear or sound similar to dividends declared by corporations, there are significant distinctions between the two :
- Dividends are paid by corporations from their profit after tax (PAT): Generally, companies distribute dividends after preserving a portion of their profits in reserves and surplus accounts for future growth. The company’s management chooses how much of the earnings should be distributed to shareholders as dividends and how much should go to the reserve and surplus account.
- Mutual fund plans can only pay dividends on the scheme’s accumulated earnings. The dividend (IDCW) payout rate per unit is determined by the AMC. However, whether the scheme pays dividends or not, the cumulative earnings of the scheme belong to the investors and are represented in the scheme’s NAV (Net Asset Value). A scheme’s Net Asset Value (NAV) will always decrease when a dividend is paid out. After the dividend is paid, the NAV will decline accordingly and be readjusted.
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