All You Need to Know About Income Distribution cum Capital Withdrawal Option of Mutual Funds

When you invest in mutual funds, you have broadly two options to choose from. You can choose the Growth option or the Income Distribution cum Capital Withdrawal (IDCW) option. The latter was earlier known as the Dividend option.

The underlying portfolio of growth, IDCW or any other option of a scheme is the same. However, the difference lies in the way the scheme distributes the profits under each option.

If you opt for the growth option, the profits made are reinvested in the scheme, which is reflected in the NAV. Whereas in the IDCW (erstwhile dividend) option, profits are distributed to the investors either partially or fully at the discretion of the fund manager.

In April 2021, the capital market regulator SEBI directed mutual funds to rename the Dividend option as the IDCW option. The objective behind this was to use the correct nomenclature. Many investors misunderstood dividends declared by mutual funds as a bonus over and above the returns delivered by a scheme. This was quite misleading and could affect an investor's investment plan. Therefore, SEBI decided to rename the Dividend plan to IDCW to explain the differences clearly, avoid misconceptions, and promote transparency.

The dividend declared by a mutual fund is, in fact, the income arising from the investors’ invested capital. This is why the NAV of the scheme falls to the extent of the dividend paid by the scheme under the IDCW plan. The resulting reduced NAV after the payment of the dividend is called ex-dividend NAV.

It is important to note that IDCW declared by mutual fund schemes are subject to distributable surplus, which is a function of market conditions and the performance of the scheme. Distribution of scheme profit by way of IDCW is declared at the discretion of the fund manager. IDCW may include dividends paid by the underlying stocks and capital gains made by selling such stocks from the scheme’s portfolio.

In the payout of the IDCW option, investors receive the income in their registered bank account. Accordingly, the number of units held by an investor in the scheme remains the same.

In the case of Reinvestment of the IDCW option, investors do not receive the income in their bank account. The income payments are reinvested in the scheme, and unitholders receive additional units.

The transfer of IDCW is a facility that allows investors to automatically transfer IDCW earned in a mutual fund to another scheme within the same fund house, for instance, from debt to equity fund. Mutual funds generally specify a minimum amount of income that can be transferred.

IDCW taxation

As per the income tax rules, with effect from April 01, 2020, dividends received from mutual fund schemes are taxable in the hands of the investors as per the income tax slab applicable to them. Thus, if you fall under the 30% tax bracket, you will have to pay 30% tax on the IDCW amount.

In addition, a TDS at the rate of 10% will be applicable if the dividend amount exceeds Rs 5,000 in a financial year. Consequently, the taxes will eat into your returns. Thus, the IDCW is not a tax-efficient option, especially for those in the higher tax bracket.

Should you opt for the IDCW option?

Investors generally opt for the IDCW option to earn a regular stream of income. However, it would not be wise to depend on IDCW for a source of income because there is no assurance on the timing and quantum of profit distribution.

Furthermore, since the profits of the scheme are periodically paid out to investors money, it puts brakes on the process of compounding.

On the other hand, if you opt for the Growth option, that will help your money grow through the power of compounding as the profits are reinvested in the scheme. And if you want a regular inflow through your invested mutual funds corpus, you can opt for the Systematic Withdrawal Plan (SWP) option, which will allow you to withdraw a fixed amount at a pre-specified regular interval.

Happy Investing!

Above article is authored by Quantum.

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