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Mutual funds are versatile, offering various plans to suit different investment goals. They are widely used for long-term wealth creation, allowing investors to either put in money regularly through SIPs or make a one-off, lump-sum investment, typically reaping profits after some time.
However, there’s an additional, less-known benefit of mutual funds – the ability to generate a regular income stream independent of the fund’s overall profit generation. This feature is known asIDCW full form Income Distribution cum Capital Withdrawal.
This aspect of mutual funds often goes unnoticed but can be a significant addition to your financial strategy. It opens up possibilities for managing cash flows or even supplementing income. So, if you’re curious about how IDCW can fit into your investment strategy and provide regular income, keep reading.
What is IDCW in mutual funds?
In mutual funds, you usually come across two main options: a Growth Plan and a Dividend Plan. The Dividend Plan was renamed to IDCW by SEBI in April 2021. This change was made to clear up any confusion between dividends from stocks and mutual funds, ensuring investors have a better understanding of their mutual fund earnings.
In IDCW vs growth plan, the underlying investments remain the same. The difference lies in how profits are managed and distributed.
In the IDCW option, you have the flexibility to receive returns from your investments as regular payouts. This means you can get a portion of the fund’s profits at specified intervals, providing a source of periodic income.
The nomenclature of IDCW more accurately reflects its nature. When a mutual fund scheme distributes income, it’s not just handing out profits. This income usually includes dividends the fund has received and any capital gains it has realised by selling its underlying securities.
In simpler terms, what many investors think of as dividends are actually a portion of their own investment’s value being returned to them. This is why the Net Asset Value (NAV) of a mutual fund scheme drops proportionally after the distribution of IDCW. The NAV gets adjusted downwards because part of what’s being paid out as IDCW is effectively the capital you initially invested. It’s this readjustment that aligns the NAV with the scheme’s current value post IDCW payment.
How does IDCW work?
When a mutual fund makes a profit, it has two choices: either reinvest these profits back into the fund or distribute them to its investors. If the fund opts for distribution, it does so through IDCWs.
The amount of IDCW an investor receives is influenced by the fund’s NAV and the investor’s holding period. The NAV at the time of distribution helps determine the value of the payout, while the holding period can affect the applicable taxation on the IDCW received.
For example, let’s imagine you invested ₹50,000 in a mutual fund scheme where the NAV is ₹10 per unit, which means you own 5,000 units. The mutual fund house then declares an IDCW of ₹1 per unit. As a result, you’re eligible to receive an IDCW payout of ₹5,000, which will be credited to your account.
During this period, let’s say the NAV of your fund increases to ₹15 per unit. This growth raises the value of your investment to ₹75,000. If you choose to redeem your IDCW of ₹5,000, the NAV, excluding IDCW, adjusts accordingly. After the IDCW withdrawal, the adjusted NAV might drop slightly, and your total investment value would be recalculated based on this new NAV.
For instance, if the NAV adjusts to ₹14 post IDCW withdrawal, the value of your remaining investment would be ₹70,000 (5,000 units at ₹14 per unit). This scenario illustrates how the fund value can change depending on the NAV’s performance over time and the impact of IDCW withdrawals on your investment.
These payouts can be set up to happen regularly, like every month or quarter, providing a consistent stream of income. In contrast, IDCW Interim is an unscheduled distribution made based on the fund’s performance and surplus at a particular time, adding an element of flexibility to income generation
Taxation in IDCW schemes
In IDCW schemes, tax is important to consider. Until 2020, companies paid dividend distribution tax (DDT), but now, after the Finance Act 2020, the shareholders pay tax on IDCW income if it’s over ₹1 lakh per year. This is taxed as ‘Income from Other Sources’ based on your tax slab. Also, if your IDCW income exceeds ₹5,000, Tax Deducted at Source (TDS) applies.
For special IDCW payouts, Capital Gains Tax (CGT) is charged. If you hold units for more than 36 months, it’s taxed as long-term at a lower rate. For shorter holdings, it’s taxed as short-term according to your tax slab.
Bottomline
IDCW in mutual funds offers a versatile investment option, blending regular income payouts with long-term growth potential. Its flexibility, diversification, and cost-effectiveness make it appealing.
FAQ
IDCW in mutual funds refers to Income Distribution cum Capital Withdrawal. It allows investors to periodically receive a part of their investment as income, which includes both earnings and a portion of the invested capital.
Whether a Growth or IDCW fund is better depends on your financial goals. Growth funds are ideal for long-term capital appreciation, while IDCW funds provide regular income. Choose based on your need for periodic payouts versus reinvesting for compound growth.
Dividends typically refer to the distribution of a company’s profits to its shareholders, while IDCW in mutual funds is a mix of income distribution and return of a portion of the investor’s capital.
Yes, if you invest in a mutual fund with a dividend option now called IDCW through a SIP, you can receive IDCW payouts, subject to the fund declaring them.
An IDCW payout in mutual funds is a distribution to investors that combines income earned from the fund’s assets and a portion of the invested capital. It provides regular income to investors.