IDCW mutual fund: All you need to know!

IDCW mutual fund: All you need to know!

Last updated: 22 Nov, 2021 | 04:51 pm

IDCW Mutual Fund: IDCW in Mutual Funds, IDCW Meaning Explained | INDmoney

What is IDCW in a Mutual Fund?

Investing in the stock market requires that investors be aware of the terminology associated with it and any regulatory changes introduced by regulatory agencies. An example of this is IDCW. Let's discuss it in more detail.

Investors can choose from either growth, bonus or a dividend option regarding realised profits. Unlike the other two options, investing in dividend options means that the investor will receive dividends for the gain from the underlying mutual fund scheme. In other words, profits from the scheme are reinvested in the scheme and made available to the investors as dividends.

Investors can either opt for dividend payout or reinvest. The dividend payout means a payout of declared gains to the investors. However, the dividend reinvest involves the purchase of additional units to the investors. Dividend distributions can be quarterly, half-yearly or annual.

To understand what IDCW in a mutual fund scheme represents, we must first understand what IDCW stands for. The IDCW full form in mutual funds is Income Distribution cum Capital Withdrawal. A dividend option in mutual fund markets is now known as IDCW mutual fund.

In April 2021, SEBI introduced this name change. Apart from this, SEBI has also changed the names of dividend reinvestment options and dividend transfer plans. The former is renamed the reinvestment of income distribution, while the latter is the transfer of income distribution and capital withdrawal. The mutual fund houses must rename all three dividend plans in all their new and existing dividend plans. Furthermore, as per SEBI regulations, they must communicate to their investors that a portion of their capital can be distributed as dividends.

New Rule on Dividend Plans

SEBI has introduced some new rules governing dividend plans to improve investor transparency and control in the mutual fund market. We have already talked about the name change of dividend options to IDCW in mutual funds.

As a result of the new rules, the top 1000 listed companies, according to market capitalisation, are required to formulate a dividend distribution policy. The rest of the companies, if they wish, may disclose the same on their websites and provide a link in their annual reports. In addition, SEBI has amended the Listing of Obligations and Disclosure Requirements (LODR) and put in place a framework for the constitution and role of the Risk Management Committee.

Furthermore, listing firms must provide audio and video recordings of analyst and investor meetings on their website and at stock exchanges within 24 hours or before the following trading day.

According to the new rules, dividend income is now taxable in the hands of the unit-holder. As it is no longer an exempt income, the ITR reporting has also changed. The dividend income will now be shown under the head 'Income from other sources'.

Why Did SEBI Rename the Dividend Plan as the IDCW Plan?

In simple terms, dividends are gains that an investor receives over and above his investment. However, this wasn't the case in mutual funds. While the investor receives profits, known as dividends, at the same time, the NAV of his investment gets reduced by the same amount. In reality, there is no gain or additional payout. It's like withdrawing money from your capital. Therefore, SEBI decided to rename the gain as 'distribution', as it always was in reality. The IDCW meaning in mutual funds is the same as what dividend meant before. This name change is solely for clarity.

Investors are unaware of the difference between income distribution and capital distributions when it comes to mutual funds. The former indicates an appreciation of NAV, whereas the latter indicates the amount in equalisation reserve or investor's capital.

When units are sold at a higher price than their face value, realised gains are transferred to a separate account called the equalisation reserve account. Dividends are paid from this account.

Hence, SEBI decided to rename its existing dividend plan to Income distribution cum capital withdrawal (IDCW) to explain the differences clearly and promote more transparency. Consequently, mutual fund houses need to communicate this to investors and include it in their offer documents.

How Does the IDCW Mutual Fund Work?

We have established above that mutual fund dividends are only the amount of capital appreciation paid from the investor's capital; hence the reason for changing the name from 'dividend plan' to a more accurate 'income distribution plus capital withdrawal (IDCW) plan'. Let's explain this with an example.

  • A unit-holder owns 5000 units of a dividend or IDCW mutual fund scheme, and the NAV of the fund is Rs 10. This NAV is inclusive of dividends. Consequently, the total investment value of the unit-holder is Rs 50,000.
  • Let us say that a mutual fund declares a dividend of Rs 2. As a result, the unit-holder is entitled to receive Rs 10,000 (Rs 2 * 5000 units) as a dividend or IDCW. This amount will be credited to the investor's capital account or equalisation reserve with the fund.
  • If the unit-holder redeems this amount, the NAV excluding dividends comes to Rs 8 (10-2). Thus, the total investment is Rs 40,000 (Rs 8*5000 units).
  • If we compare the before and after dividend payout scenarios, the investor receives Rs 50,000 in both cases. Hence, nothing changes. Thus, we can say that the investor withdrew Rs 10,000 from his capital only.
  • In contrast, if the investor had invested in a growth option scheme, there would have been no dividend payout, and their capital would have remained intact.

An investor's IDCW income is added to their gross taxable income and taxed following their tax slab. Furthermore, if the investor's total dividend exceeds Rs 5000, they will be subject to TDS.

Is There Any Difference Between Dividends Declared by Mutual Funds and Companies?

While the name may be the same, dividend meaning is different for mutual funds and companies. Both of them are subject to different rules. A dividend payout is not mandatory for companies. It is at their discretion whether to declare one. If they do declare, they must follow specific guidelines as laid out in the Companies Act.

This is not the case for mutual funds. All mutual fund schemes must declare their accumulated dividends at least once a year. Dividend payout mutual fund schemes must distribute regular quarterly, half-yearly, or annual dividend payouts to investors.

Another difference is the effect on NAV value after dividend payout. Whenever a mutual fund pays out dividends, its NAV falls by the same amount. However, in a company, the share price may or may not decline.

Additionally, companies have the right to decide what part of profits to pay to their shareholders. However, with mutual funds, all accumulated profits eventually belong to the unit-holders. The AMC has only the right to determine the dividend rate.

Should the Investor Invest in Growth or IDCW Mutual Fund?

Investors have the choice between growth or IDCW when deciding returns on investment. If the investor can hold on to the investment amount for a long time, the growth option is preferable. The long-term growth of NAV allows investors to create wealth and achieve long-term goals. For investors who want regular funds, it is better to invest in IDCW mutual funds. The downside to regular payout is losing out on compounding gains.

Moreover, IDCW mutual funds will be beneficial only if the market is performing well at that time. If it is low, the investors will lose out on the payout. Therefore, IDCW mutual fund investors must be prepared to accept that risk.

Furthermore, their tax rules are separate. Capital gain rules apply to growth mutual fund schemes, but IDCW income is added to investors' taxable income and is subject to their normal slab rates.


Where can you see the 'IDCW' term in the offer documents?

Investors can now see the IDCW term next to a mutual fund scheme name on their account statement. Further, SEBI specifies that mutual fund houses must communicate with their clients and include this change in their offer documents.

Can you switch from IDCW to the growth option?

Yes, investors can change from IDCW to a growth option or vice versa. However, this switch is equivalent to redemption, and hence, it will attract an exit load and capital gains tax. Whether it is a long-term or short-term capital gain tax, it all depends on the holding period. Accordingly, investors should consider these expenses before making a switch.