Decoding IDCW in Mutual Funds

In April 2021, the dividend option in mutual funds was changed to Income Distribution cum Capital Withdrawal or IDCW in mutual funds. It allows investors to earn dividend income which is distributed by the fund houses from their profit. When this profit is reinvested in the scheme’s assets, it is known as a growth option. 

Investors can potentially benefit from this IDCW option by understanding its mechanism, planning based on its execution and striking the difference between IDCW and growth options for their investment.

What is IDCW in Mutual Funds?

Dividend or now known as Income Distribution cum Capital Withdrawal option provides a part of the profit to its investors as a dividend. However, mutual funds do not directly transfer this dividend from stocks to all the unit holders. The mutual fund schemes are segregated mainly into two options based on their dividend distribution:

• Growth 
• Dividend or IDCW

The specific option of IDCW in mutual funds allows investors to decide whether to get the dividend income or reinvest it.  

The term ‘IDCW’ was introduced recently. Previously, it was known as a dividend option. However, in April 2021, it was changed to Income Distribution cum Capital Withdrawal. 

Source: Associations of Mutual Funds in India (AMFI)

The purpose of this change was to clarify the nature of the dividend distributed among the investors. In this option, the profit earned is not an extra income but a part of the total capital of that fund.

How does the IDCW in Mutual Funds Work?

The dividend earned through the IDCW option can become a potential income source for many investors. This dividend, earned by the investors, is not the one distributed by companies. It is from the profit of mutual fund houses or Asset Management Companies (AMC). The profit can be from the sale of units or from the income of investment, such as interest and dividends.

The profit earned is first transferred to the dividend equalisation reserve and later distributed at the discretion of the fund house. Moreover, it is expressed as the % of the face value of a unit. The following hypothetical example may clear the case for IDCW option calculation.

Understand what is IDCW in mutual funds with an example.

Mr MNO invests ₹3 lakhs in the mutual fund scheme with IDCW option. The NAV at the time of purchase was ₹120. Therefore, 2500 units (3 lakhs/120) were earned. 

The fund house declares a 40% dividend, which will be charged on the face value. Face value of a mutual fund is the amount at which investors buy the units at the time of NFO.

Total amount invested	₹3 lakhs
Total units	2500
NAV per unit (before dividend)	₹180/-
Investment Amount (before dividend) (180*2500)	₹4.5 lakhs
Face Value per unit	₹20
Dividend per unit (20*40%)	₹8/-
Total dividend (8*2500)	₹20,000/-
Ex-dividend NAV (after) (180-8)	₹172/-
Investment Value (after dividend) (172*2500)	₹4.3 lakh

Post the dividend distribution, the NAV decreased by a similar amount. Here, the dividend amount is more than ₹5000 threshold. Therefore, post 10% TDS deduction, it will also be taxable in the investor’s income.

However, this distribution of dividends will differ for various types of the IDCW option.

Types of IDCW Options

Based on the execution of IDCW in mutual funds, there are three types:

1. Payout

Here, the distributed dividend is deducted from the total assets of that fund and distributed among the unitholders. It creates an additional income source for the investors.

2. Reinvestment

This type allows investors to reinvest the dividend in the same fund. Due to this, a new set of units is purchased with the received dividend, and total units increase for a particular folio.

3. Transfer

It provides an option for investors to transfer the dividend to another scheme within the same fund house or category (as per the AMC norms). It helps in diversifying the portfolio without extra investment costs.

Understanding the difference between the two options in mutual fund schemes helps investors select a suitable investment.

Taxation of IDCW in Mutual Funds

After April 2020, the dividend earned by investors becomes taxable under the head of ‘Income from other sources’ if it exceeds ₹5000 threshold. Above this limit, the dividend is also liable for the treatment of Tax Deducted at Source (TDS) by the mutual fund house before distribution. The rate for this TDS charge is as follows:

• Investors with Permanent Account Number (PAN) = 10%
• Investors without PAN card = 20%
• NRI investors = the lower of 20% or rate as per the Double Tax Avoidance Agreement of their resident country 

Growth Option vs IDCW Option

Points of Difference	Growth Option	IDCW Option
Dividend payout	Investors do not get the dividend benefit as it is reinvested in the scheme’s assets.	Investors receive dividend income, which can be withdrawn, reinvested or transferred.
Ex-dividend NAV	Due to an increase in total assets and constant units, the NAV increases after profit.	Due to dividend distribution from profit, the total assets decrease, and the NAV falls post-dividend.
Taxation	Tax liability arises only when investors sell the units, and capital gains arise from this transaction.	A dividend above ₹5000 is taxable for investors along with TDS. Also, capital gains will be taxed.
Suitability	Investors with a long-term perspective may find growth options suitable.	Investors with a frequent requirement of income will find the IDCW option suitable.
Compounding benefit	Higher than the IDCW option due to  the absence of any withdrawal.	Lower than the growth option due to dividend payout.

The total profit for a particular fund is the same for these two options. The main difference is visible in their total assets and NAV after the dividend distribution.

Conclusion

Previously known as the dividend option, the IDCW facility is a potential income source for investors willing to earn dividends without direct stock market exposure. However, it is crucial to understand the mechanism of this option to mark its implications on the scheme NAV. Investors can decide between their suitability for growth or IDCW in mutual funds after understanding the difference between them and analysing their personal objectives.

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FAQs on IDCW in Mutual Funds

1. How does IDCW work?

The dividend option or IDCW allows the investors to get a dividend when the mutual fund houses book profit. This profit can be through a sale of securities or from other incomes of dividends and interest from invested assets. Investors in the IDCW option will receive this payout, while in the growth option, it will be reinvested.

2. What are the disadvantages of IDCW in mutual funds?

Usually, the NAV decreases after dividend payout as the total funds against outstanding units decrease. This income earned by mutual fund investors will be charged at 10% TDS. Moreover, due to the fund house’s discretion, the income may not be a stable source.

3. How is tax charged on income from IDCW?

Through the IDCW option, if an investor earns a dividend of more than ₹5000, they will be charged 10% TDS for all the categories. Apart from this, if an investor does not have a PAN card, this TDS charge by AMCs will be 20%. For NRI investors, this TDS will be 20% or the rate mentioned in the DTAA of their residence country (whichever is lower).

4. Does NAV fall in the IDCW option?

Investors may find their NAV of the IDCW scheme to be higher before the distribution of dividends. However, when the dividend is distributed, the total assets of the fund house decrease, which decreases the NAV. On the contrary in the growth option this profit is reinvested the NAV may seem higher.

5. Which type of investors is the IDCW option suitable for?

Investors willing to earn a potential income above regular investment may find IDCW a suitable option. Moreover, it can also be suitable for retired individuals.