IDCW Option in Mutual Funds: A Simple Guide for Investors

The Indian mutual fund industry has grown incredibly fast over the past 10 years. The total assets under management, or AUM as on as on July 31, 2024, stood at ₹64.97 trillion.

What confuses most investors is the right option to choose when investing in mutual funds. There are broadly two options to choose from:

• Growth option or
• Income Distribution cum Capital Withdrawal or IDCW option, which was previously called dividend option.

The dividend option to renamed to IDCW in April 2021.

Let us get into the meaning of IDCW in mutual funds in detail!

What is IDCW in mutual funds?

IDCW full form is Income Distribution cum Capital Withdrawal plan.

What is IDCW? By IDCW - we mean an option where the mutual fund scheme’s returns are distributed to the investors subject to distributable surplus of scheme partially or fully at regular intervals, earlier known as dividends. These intervals may be monthly or based on decided by the Trustee.

Say you purchase 5000 units of a mutual fund scheme. It declared a dividend of ₹1 per unit. Thus, this scheme will pay you ₹5,000 as IDCW.

In IDCW option, part of the scheme’s returns is distributed as payouts, while the growth option reinvest your returns into the scheme to take advantage of compounding benefits.

The distributed income in IDCW option can come from dividends received by the stock held by the fund, interest earned on bonds or gains from selling securities held under the scheme.

Other dividend options were renamed in the following manner:

Why rename the dividend plan as IDCW?

To bring more clarity and transparency for the investors, the dividend option rename as IDCW. Many investors would confuse the word “dividend”, perceiving it as an income. A dividend is a distribution of distribution surplus of scheme leading to a decrease in mutual fund NAV or net asset value.

Let us see how IDCW in mutual funds works with an example.

Assume you own 5000 units of a mutual fund scheme. The dividend announced by the mutual fund is ₹1 per unit. That means you will get a dividend of ₹5,000. Dividend payout to the investor will be lower to the extent of Dividend Distribution Tax.

After payment of dividend, the per unit NAV of the Dividend Option of the Scheme will fall to the extent of the payout and applicable statutory levies.

Taxation of IDCW Option

Prior to 2020 - it was mandatory under the law for all companies to pay a dividend distribution tax or DDT equivalent to 15%. From April 2020 onwards, dividends earned through mutual fund schemes are taxable in the hands of investors at applicable income tax slabs.

Therefore, if you fall under the 30% tax bracket, you will have to pay 30% tax on dividends received through IDCW. Moreover, if the dividend amount paid to you in a financial year goes beyond ₹5,000, then a TDS rate of 10% would apply.

Taxation can reduce your investment returns; thus you must be aware of these tax consequences.

Should you opt for the IDCW option?

Choosing IDCW option is a matter of choice. Some factors to consider include:

1. Need for regular income - If you are looking for a regular source of income through your investments, then you may want to consider IDCW option . Note that taxes apply in this case.
2. Reinvestment strategy - Unlike growth schemes where returns get reinvested, there is no automatic reinvestment of income generated in IDCW plans.
3. Investment horizon - If you are a long-term investor, you might prefer a growth-oriented scheme, which emphasises capital gains accompanied by compounding.

Final thoughts

For some investors, IDCW plans are a good option, but there is no one-size-fits- all solution. Therefore, it is imperative to thoroughly comprehend your financial objectives and assess your risk tolerance before making any investment decisions.

To make an informed choice, conduct diligent research or consult with a financial advisor.

Remember, it’s never too late to invest. Start your investment journey today!

Above article is authored by Quantum.

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