IDCW in Mutual Funds

Unlock the power of IDCW in mutual funds. Discover all about IDCW in mutual funds like the meaning, benefits, and calculation of income distribution cumulative withdrawal before you invest.
IDCW in Mutual Funds
4 mins
08-May-2024

IDCW stands for Income Distribution cum Capital Withdrawal, focusing on reallocating a share of both capital and profit to investors, essentially refunding previously invested funds as dividends.

This blog aims to delve into the intricacies of Dividend Plans, highlighting the modifications made, and elucidating the implications for your investment portfolio.

What is IDCW (Dividend Plan) in mutual funds?

IDCW is the new name given by SEBI to the dividend option in mutual funds from April 1, 2021. In this option, the mutual fund scheme distributes a part of its profits to the investors as dividends at regular intervals.

The IDCW option is different from the growth option in mutual funds, where the profits are reinvested in the scheme and reflected in the NAV. The growth option does not pay any dividends to the investors.

Short-term Capital Gains Tax is assumed at 15%, while IDCW is assumed at the highest tax bracket of 30%. Cess and surcharge are excluded for simplicity's sake.

What is SEBI’s new rule on dividend plans?

SEBI has changed the name of the dividend option to IDCW option to make it more transparent and accurate. SEBI has also mandated that the IDCW option should clearly mention the source of distribution, by bifurcating income distribution I.e. appreciation of NAV or capital distribution  or both. The dividend payouts maybe daily, weekly, monthly, quarterly, or annually.

Who should invest in IDCW schemes?

Here are some individuals who may find investing in Income Distribution cum Capital Withdrawal (IDCW) plans advantageous:

  • Retirees: Retirees seeking a consistent income from their investments may benefit from IDCW plans. These payments can offer a reliable source of income, with favourable tax treatment for retirees.

  • Individuals with irregular income: Those with unpredictable earnings, such as freelancers or self-employed individuals, might find IDCW plans appealing. The steady income from Income Distribution cum Capital Withdrawal payments can help stabilize finances amidst fluctuating income.

  • Investors seeking convenience: IDCW plans could suit individuals who prefer to avoid the complexities of selling units from their mutual fund holdings. By opting for IDCW, investors receive regular income without the need to liquidate their units.

However, it's essential to recognise that IDCW plans may not be suitable for everyone. Investors aiming for long-term wealth growth might find growth-oriented mutual funds more appropriate.

Taxation of IDCW schemes in mutual funds

Until 2020, companies were obligated to pay a dividend distribution tax of 15% on declared dividends. However, following the 2020 budget, the dividend distribution tax levied on companies was eliminated, shifting the tax burden to shareholders' hands.

Consequently, any distributed income under Income Distribution cum Capital Withdrawal (IDCW) plans is subject to taxation based on the investor's applicable slab rate. Additionally, Asset Management Companies (AMCs) will deduct TDS if the dividend exceeds Rs. 5,000 per fiscal year. No TDS deduction will occur if the dividend income is up to Rs. 5,000.

Some common misconceptions about IDCW

Sr. no

Misconception

Reality

1

Some investors believe that dividends paid by mutual funds originate solely from the stocks in the fund's portfolio.

Dividends from mutual fund schemes can include proceeds from underlying stocks, but may also involve gains from stock sales. It is not exclusively reliant on direct dividends from portfolio stocks.

2

There is a notion that mutual fund dividends are additional earnings on top of capital gains.

Dividends received from mutual funds are not extra income; they are gains paid from invested capital. When dividends are declared, the NAV of the fund decreases by the same amount.

3

Some think that mutual funds with dividend options regularly realise profits to pay dividends.

Dividend payment is not obligatory for any mutual fund scheme; it is at the discretion of the fund manager. Whether growth or dividend option is chosen, the portfolio remains unchanged, and profits affect the entire fund. Under the growth option, profits are reinvested, while in the dividend option, profits may be distributed to investors but are not mandatory.

 

How to calculate IDCW with an example

The formula for calculating IDCW is (Total dividend received = number of units x Dividend per unit). To illustrate this, consider a shareholder with 1,000 units in a mutual fund scheme with an NAV of Rs. 100. If the scheme declares a dividend of Rs. 5 per unit, the investor's investment value would not receive an additional dividend but would be funded solely from their initial investment. Opting for the growth option of the mutual fund program would result in an investment of Rs. 1,00,000 instead of Rs. 95,000, as no dividend payments are made under this option. This change from "dividend" to IDCW was implemented by SEBI to enhance investor decision-making in mutual fund investments.

Benefits of Income Distribution cum Capital Withdrawal (IDCW)

Income Distribution cum Capital Withdrawal (IDCW) in mutual funds presents numerous advantages for investors:

  • Providing regular income: IDCW allows investors to receive consistent income distributions from their mutual fund holdings, akin to receiving a paycheck from investments. This steady income can assist in covering daily expenses or enjoying a reliable source of funds.
  • Facilitating cash flow management: Investing in IDCW mutual funds can aid in managing cash flow effectively. Regular income distributions enable investors to meet ongoing expenses, fulfill loan obligations, or plan for retirement income with greater ease.
  • Balancing income and capital appreciation goals: IDCW strikes a harmonious balance between generating income and potentially increasing investment value. Investors can enjoy periodic income while retaining the potential for their investment to appreciate over time.
  • Enhancing diversification and risk management: Mutual funds typically diversify their holdings across various securities, mitigating risk. Opting for IDCW allows investors to benefit from this diversification while receiving consistent income, thereby adding stability to their investment portfolios.
  • Leveraging tax benefits: Depending on the tax laws in their jurisdiction, investors may enjoy tax advantages with IDCW. For example, dividend income might be taxed at a lower rate compared to capital gains. Consulting a tax advisor is recommended to comprehend the specific tax implications and benefits applicable to individual circumstances.

Why did SEBI rename “Dividend Plan” as “IDCW” plan?

SEBI renamed the dividend option as IDCW option to avoid some common misconceptions among investors about mutual fund dividends. Some of these misconceptions are:

  • Mutual fund dividends are extra income over and above the capital appreciation.
  • Mutual fund dividends are guaranteed and regular.
  • Mutual fund dividends are similar to company dividends.

SEBI wanted to clarify that mutual fund dividends are not extra income or return, but a part of your own investment that is returned to you. When a mutual fund scheme pays a dividend, its NAV drops by the same amount, reducing your investment value. Mutual fund dividends are also not guaranteed or regular, as they depend on the performance and discretion of the scheme. Mutual fund dividends are also different from company dividends, as they may include capital gains as well as income from securities.

IDCW in mutual funds - The methodology

To understand how IDCW works in mutual funds, let us take an example. Suppose you invest Rs. 10,000 in an equity mutual fund scheme with an NAV of Rs. 100 under the IDCW option. You will get 100 units of the scheme. After six months, the scheme declares a dividend of Rs. 5 per unit from its capital gains. You will receive Rs. 500 as dividend (100 units x Rs. 5 per unit). The NAV of the scheme will drop to Rs. 95 (on the date of declaration) after paying the dividend. Your investment value will remain Rs. 9,500 (100 units x Rs. 95 per unit).

Just for reference, if you had invested in the same scheme under the growth option, you would not receive any dividend. However, your NAV would be higher than Rs. 95, as it would reflect the capital gains made by the scheme. Your investment value would be higher than Rs. 9,500.

Conclusion

IDCW is the new name for the dividend option in mutual funds. It stands for Income Distribution cum Capital Withdrawal and indicates that dividends are paid from your own investment value. IDCW plans may suit investors who need regular income and are in a lower tax bracket. Growth plans may suit investors who want to benefit from compounding and long-term wealth creation and are in a higher tax bracket. You should choose the option that matches your investment objective, risk profile, time horizon, and tax implications.

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Frequently asked questions

What is the full form of IDCW?

IDCW stands for “Income Distribution cum Capital Withdrawal”.

What is the meaning or definition of IDCW?

IDCW is a dividend option that provides regular income distributions to investors while allowing partial withdrawals of their capital.

How is IDCW payout determined?

The payout for IDCW is determined by the dividend declared by the mutual fund scheme.

Is IDCW subject to taxation?

Yes, IDCW is subject to taxation.

Which is preferable, growth or IDCW?

The choice between growth and IDCW depends on individual investor preferences and financial goals.

What taxes are applicable for income received from IDCW?

The taxes applicable for income received from IDCW.

What is NAV and IDCW?

NAV (Net Asset Value) represents the per-unit value of a mutual fund, while IDCW (Income Distribution cum Capital Withdrawal) combines income distribution with capital withdrawal in mutual funds.

How is IDCW calculated?

The formula for calculation of IDCW is: [Total dividend received = No. of units x Dividend per unit].

Can we change from IDCW to growth?

Switching between the dividend and growth options is feasible, requiring the sale of existing units and acquisition of new ones. Such a transition may incur exit loads and capital gains tax. Prior to switching options, it's advisable to assess both these considerations carefully.

What is IDCW interim?

IDCW interim refers to the interim disbursements made by a mutual fund within the framework of the Income Distribution cum Capital Withdrawal (IDCW) scheme.

What is IDCW payout in mutual funds?

The IDCW payout involves receiving the mutual fund's earned income (dividends and capital gains) along with a segment of the invested capital at periodic intervals.

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