IDCW in Mutual Fund: How It Works, Types, Benefits and Tax

IDCW is one of the more popular mutual fund options that provide periodic payouts from the income generated by the investments of the fund. The product appeals to those who want a regular income but, at the same time, would like their money invested in the market.

In this article, let us discuss the concept of IDCW, how these plans have changed, and how they impact your investments. Amidst the changing environment, mutual fund investors need to understand IDCW to make informed decisions.

What is IDCW in Mutual Funds?

IDCW full form in mutual funds is Income Distribution cum Capital Withdrawal. This is a type of investment payout plan offered by mutual funds, where the investors are allowed to receive their returns on their investments on a regular interval.

In IDCW plans, a portion of the investor's capital is distributed as a dividend. Usually, these dividends are declared by the fund houses in the case of surplus cash generated by the scheme. Further, investors can receive IDCW payments from the NAV of mutual funds even if the fund does not make profits since the IDCW payments enclose income and capital withdrawal, allowing investors to receive consistent returns on their investment.

It is important to know when the mutual fund declares IDCW, the value of the NAV is reduced rather than a decrease in the number of NAV units that the investors hold. Furthermore, the dividends are not always guaranteed under the IDCW scheme. It is rather dependent on the profits accumulated by the mutual funds and the decisions made by the AMC regarding the payout rate.

How do IDCW in Mutual Funds Work?

Many investors wonder how the IDCW option in mutual funds works. So here is a detail about the methodology of the IDCW plans:

Profit Distribution: Whenever the mutual funds make profits, it has 2 options. The fund manager can either reinvest the profits or distribute it to the unitholders. If the fund house

Choose to distribute the profits, it issues IDCWs as dividends.

Regular Payout: IDCW payouts can be made regularly like monthly, quarterly, annually, and semi-annually thereby creating a regular income stream for the investors benefitting them

Tax Implications: IDCW payments are tax-efficient ways as they are taxed as capital gains by authorities. These are taxed often at a lower rate than regular income. However, if the total IDCW payment exceeds Rs 5,000 TDS(Tax deducted at source) may apply.

NAV Impact: Net asset value(NAV) usually tends to decrease when mutual fund houses distribute IDCW since it is considered a capital withdrawal

SEBI’s New Mandate for Dividend Schemes

Due to misconception among the investors regarding the dividend plans on mutual funds SBI changed the nomenclature of the ‘dividend’ plan. As per the SEBI regulation, with effect from April 1, 2021, There is no such thing as 'Dividend' in Mutual Funds now. Instead 'Dividend' is now simply called 'distribution'. And the 'Dividend Plan' of a Mutual Fund scheme is now called the 'Income Distribution cum Capital Withdrawal Plan' or IDCW Plan.

Types of IDCW Plans in Mutual Fund

There are 2 main types of IDCW plans in mutual funds schemes.

Regular IDCW

The regular IDCW plan provides regular payments to investors which helps them have a stable income through periodic distributions like monthly, quarterly, annual, and semi-annually. Though it reduces the total invested amount, it is suitable for retirees and those who need a steady cash flow. 

Growth IDCW

Unlike regular IDCW, the Growth type does not distribute regular payments. Instead, they automatically reinvest the amount back into the fund leading to compounded returns, Benefiting long-term capital appreciation. This type is ideal for those investors who do not require immediate cash payments and are looking to accumulate wealth over the long term.

Also Read: IDCW vs Growth

Benefits of IDCW in Mutual Fund

IDCW in mutual funds has several benefits for investors who look for regular and stable income. So here are some of the Benefits of IDCW plans 

Regular Income Generation: IDCW plans offer investors regular and stable income generation which is similar to paychecks. This helps them to cover their daily expenses or serve as a stable income stream. Especially for retirees or individuals needing consistent cashflow.

Diversification and Risk Management:  Normally, mutual funds spread risks by diversifying their portfolio through investing in various assets. Henceforth, investors get the benefit of a diversified portfolio while receiving regular income. 

Balance between Income and Growth: IDCW plans offer the chance of regular income but still have the potential for capital appreciation. therefore, balancing income and growth, making them quite appealing to those looking for income generation without sacrificing long-term growth potential.

Taxation Benefits: By their nature, IDCW distributions often can be taxed at a lower rate than regular income under the dictate of local tax regulations. This could make IDCW a more tax-efficient way to receive income.

Taxation on IDCW Funds Schemes

IDCW is taxable under capital gains tax, which is normally lower than the tax rate on regular income. The tax rate on IDCW depends on the holding period, i.e. if held for less than 3 years, it is taxed as short-term capital gains. If held for more than three years, it is taxed as long-term capital gains.

If the distributed IDCW payments are more than Rs.5,000 in a financial year, the mutual fund house will deduct TDS at the rate of 10%

Check out our latest blogs and learn more about tax haven, SWP in mutual fund and XIRR in mutual fund.

Should You Invest in IDCW Funds?

Mutual funds grow with the market and have good returns compared to other investment options such as FD. Though it has market risk, it offers various options for investors to invest in. Income Distribution and Capital Withdrawal is one of the payout options offered by mutual fund schemes for investors

Investing in IDCW funds offers both dividend and growth plans which is helpful for the investors. As we discussed earlier, both plans invest in the same portfolio and the difference between them is the nature of payout. 

If you are seeking regular and stable income, a Dividend plan is ideal for you since it allows investors to get a periodic withdrawal of their capital and returns.

Investing in a Growth fund allows investors to reinvest their returns generated by the mutual fund scheme thereby benefitting investors to get compounding returns and accumulate wealth over the long term

Myths about IDCW (Income Distribution cum Capital Withdrawal)

Some of the common misconceptions about the IDCW are as follows:

Myth 1: Most investors think dividends that mutual funds pay out are directly compensated by the stocks in the mutual fund portfolio.

Reality: The mutual fund schemes can generate dividends on the portfolio stocks. However, in such a case, these are also likely to involve gains from the sale of these stocks in the portfolio. It is not necessarily going to be based on the direct dividends received from the same underlying portfolio stocks.

Myth 2: Mutual fund dividends are additional income over and above the capital gains.

Reality: The dividends that come from mutual funds are not incremental to capital gains. It is your gain and is paid from your capital itself, as when a dividend is declared, the NAV of the fund reduces by the same amount. For example, if the fund declares Rs 1 per unit dividend, then the NAV of the fund will also be reduced by Rs 1 per unit.

Myth 3: People believe that mutual funds with the dividend option book profits frequently to pay dividends.

Reality: It's wrong because payment of dividends by mutual fund schemes in any case is not compulsory. The fund manager can or cannot distribute dividends as per his choice.

Conclusion

In simple words, IDCW mutual fund schemes can be one of the best alternatives to traditional instruments like fixed deposits or any other government-backed savings scheme that offers the combination of regular income generation associated with high flexibility in capital withdrawal.

Rupeezy brings you a wide catalog of top-performing IDCW mutual fund schemes in India right at your fingertips. Our platform simplifies the investment process. You can browse schemes, upload essential documents, and open a demat account with ease. IDCW plans to give a proper balance between the distribution of income with capital appreciation and hence is suitable for the divergent needs of various investors.

It is important to align these investments with your financial goals and risk tolerance. Rupeezy App provides all the necessary tools and resources to make appropriate investment decisions that will help in meeting our financial goals. Explore Rupeezy today and take the first step toward a well-rounded investment strategy.