IDCW in Mutual Funds

What is IDCW in Mutual Fund?

IDCW full form is Income Distribution cum Capital Withdrawal. It is a mutual fund option where investors receive periodic payouts from the scheme. These distributions may come from the fund’s profits, such as dividends or interest, and in some cases, a part of the invested capital is also returned. This gives you liquidity without selling units, but part of your own investment may be returned as dividends.

Key Features of IDCW in Mutual Funds

The IDCW option in mutual funds offers several features that make it appealing for investors who prefer regular income while staying invested:

• Frequent income: IDCW allows investors to receive periodic distributions from the fund, much like a paycheck. This income can be used to meet daily expenses or provide a steady source of cash flow.

• Easier cash flow management: Regular payouts help investors manage ongoing expenses, repay loans, or generate retirement income without redeeming their units.

• Taxation at the investor’s end: IDCW payouts are added to an investor’s taxable income and taxed as per the applicable slab rate.

• Two variants available: There are two main types of IDCW plans:

  • IDCW Payout Option: The fund distributes accumulated profits to investors at set intervals. After the payout, the scheme’s Net Asset Value (NAV) decreases by the distributed amount.

  • IDCW Reinvestment Option: Instead of receiving cash, the payout is reinvested into the same scheme, giving investors additional units. The NAV is reduced by the payout amount, but the total investment value remains adjusted through more units.

How Does IDCW in Mutual Funds Work?

When you invest in the IDCW in mutual funds, the fund distributes a portion of its income or gains at regular intervals. The process can be understood step by step:

• Income Generation: The mutual fund earns income through interest, dividends, or profits from selling assets. For example, let’s say you hold 800 units of a scheme with a current NAV (cum dividend) of ₹120, making your investment value ₹96,000.

• Surplus Evaluation: The Asset Management Company (AMC) reviews the distributable surplus available for payout before declaring IDCW.

• Declaration of IDCW: Suppose the AMC declares ₹4 per unit as IDCW. With 800 units, you receive ₹3,200 credited to your bank account.

• Distribution of Payout: This payout is transferred directly (payout option) or reinvested to buy additional units (reinvestment option).

• NAV Adjustment: Once the IDCW is paid, the NAV reduces by the payout amount. In this case, the NAV falls from ₹120 to ₹116, so your remaining investment value becomes ₹92,800.

• Overall Position: You received ₹3,200 as IDCW, but your fund value reduced by the same amount. The total wealth remains ₹96,000, simply split between cash in hand and reduced NAV.

This shows why SEBI replaced the term “Dividend” with IDCW, to make it clear that the payout is not an additional gain but part of the invested value.

Misconceptions About Mutual Fund Dividends

There are several common misconceptions about dividends in mutual funds that often confuse investors. Understanding these will help in making better investment decisions:

• Dividends come only from stock dividends: In reality, IDCW payouts may include dividends from the underlying stocks as well as profits realised by selling securities in the portfolio.

• Dividends are extra income: IDCW is not an additional return over and above capital appreciation. It is distributed from the fund’s profits or capital, which is why the Net Asset Value (NAV) reduces after payout.

• Dividend options book profits separately: The portfolio for growth and IDCW options is the same. Profits are booked at the scheme level, and the difference lies only in distribution. In the growth option, profits remain invested and are reflected in the NAV, while in the IDCW option, a portion may be distributed to investors at the discretion of the AMC.

Things to Consider Before Investing in IDCW in Mutual Funds

These factors will assist in making a better judgment and maximising your returns when deciding to invest in an IDCW mutual fund scheme:

• Dividend Structure: Ensure you are familiar with the source of the distributions. The profits of the Fund or other sources, such as interest income, can serve as sources of IDCWs. Before deciding whether the dividends will likely be sustained, always compare the fund's past performance to confirm this.

• Dividend Distribution Frequency: State the frequency of payments of IDCWs in advance, i.e., monthly, quarterly, or yearly. Ensure the frequency of payouts is mutually related to financial needs.

• Dividend Taxation: Dividends paid to you due to IDCW schemes are subject to income tax as per your tax slab income rate. A large tax bracket may also reduce your returns due to the obligation to pay ta, which reduces your earnings. One should calculate tax returns to estimate whether the scheme is appropriate for you.

Who Can Consider IDCW?

IDCW in mutual fund schemes is suitable for investors who need a steady flow of income without redeeming their investments. These plans are especially useful for:

• Retirees: IDCW in mutual funds provide regular income to retirees so that they able to meet their day-to-day expenses, ensuring retirees do not need to liquidate their assets.

• People with Irregular Income: Independent contractors or professionals with fluctuating earnings can benefit from the stability of periodic payouts.

• Investors Seeking Simplicity: Best-suited for those who prefer receiving income directly rather than selling units from their portfolio.

IDCW in Mutual Funds: Tax Implications

Earlier, mutual fund dividends were subject to Dividend Distribution Tax (DDT), paid by the fund house before payouts. Effective April 1, 2020, this was abolished, and IDCW payouts are now taxed in the hands of investors as per their income tax slab. For instance, if an investor is in the 30% tax bracket, IDCW is taxed at 30%. If the total IDCW from a fund house exceeds ₹5,000 in a financial year, a 10% TDS is deducted before payment. This limit will increase to ₹10,000 from FY 2025-26.

This system is more transparent but less tax-efficient for those in higher tax brackets. Growth options usually offer better post-tax returns because STCG on equity funds is taxed at 20%, while LTCG above ₹1.25 lakh annually is taxed at 12.5% without indexation, which is generally lower than slab-rate taxation on IDCW.

Key Takeaways

Hope you have a fair understanding of IDCW meaning now. IDCW in mutual funds provides a steady income for investors who need a regular payout but do not want to liquidate their funds. However, IDCW schemes may not be suitable for maximum growth since payouts come from the fund’s profits, reducing its net asset value (NAV). Before investing, the dividend structure, the frequency of dividend payment, and the tax should be carefully considered. 

For investors aiming to balance income with long-term wealth creation, a Systematic Investment Plan can be a better alternative. You can start SIP in the best mutual funds in India to build a disciplined investment habit while targeting higher growth potential.