IDCW: What is IDCW Plan in Mutual fund?

IDCW in Mutual Funds FAQs

If you have been a long-term investor in mutual funds, you might have heard about the Dividend Option that mutual fund companies offer. In this option, dividends are not reinvested and instead distributed among unitholders.

IDCW or Income Distribution cum Capital Withdrawal is just the new name for this option. The Securities and Exchange Board of India (SEBI) changed the name of this option in April 2021. This is only a change in terminology and as such, there is no impact on investors.

Why did the SEBI change the name?

SEBI just wanted to bring more clarity to investors. When someone less savvy about investments hears the Dividend Option, it gives a sense that such mutual funds will also pay dividends like companies pay that to shareholders. However, this is far from the truth.

The new name, though a little longer, emphasises that this income that is distributed to unitholders is coming out of investors’ own money – which includes the dividend paid by the companies and returns generated on the investment.

According to the SEBI, all such plans are named accordingly:

How do IDCW plans differ?

The key difference between IDCW plans and Growth option plans is that the former regularly distribute income among unitholders. In the latter option, the income in the form of dividends is reinvested.

Thus, the growth option gets the benefit of compounding as all extra income is used to purchase more equity. However, the impact of compounding is not efficiently visible in the IDCW option.

Investors should also not have any misconception that dividends paid by IDCW mutual funds are actually paid by the underlying stocks. They can be dividends and any return generated on investment after the fund manager books gains.

Furthermore, there should be no misconception that payout in IDCW is extra income above the market return generated on investment. Every time dividends are paid out, the net asset value (NAV) of IDCW plans is reduced by the extent of the dividend paid to investors.

How does the dividend paid by IDCW plans impact returns?

Since NAV is negatively impacted when an IDCW plan pays out dividends to unitholders, overall returns are relatively lower compared to growth option of the same fund. NAV reflects how much capital appreciation has happened in a fund over time.

Let us understand how dividend distribution impacts the return by the following illustration:

Let us assume that you are an investor in the IDCW option of a large-cap fund. Assuming the current NAV of the fund is Rs 10 and you hold 1,000 units of the fund. The total value of the investment right now is Rs 10,000.

The fund manager of the largecap fund pays Re 1 per unit divided (this means a 10 per cent yield) to unitholders. The NAV of the fund will be adjusted to Rs 9 per unit to reflect the dividend payout. Moreover, you can note that if you include the dividend paid to you and the value of the investment after the dividend payout, it is equal to the value of the investment before the dividend payout.

How Does Income Distribution cum Capital Withdrawal Work?

1. Income Stream: IDCW offers regular payouts from your mutual fund investment. This can include dividends from stocks and interest earned by the fund.
2. Capital Withdrawal: These payouts can also come from your initial investment amount. So, you're receiving income and taking back some principal. 
3. Impact on Growth: Unlike the growth option (where payouts are reinvested), IDCW payouts reduce your total invested capital. This can potentially lower long-term growth.
4. Who benefits: IDCW suits investors seeking regular income, like retirees. It provides some capital access while still being invested.
5. Not free money: Remember, IDCW distributions are not extra returns. They come from your investment, so your total holdings may decrease.

Should you invest in the IDCW option?

The answer depends on your needs. For instance, if you are a salaried person who does not need additional income every month or at periodic intervals, opting for the IDCW option makes no sense. Investing in growth options that benefit from compounding over time will be perfectly fine.

However, there are certain scenarios where this option can work. For example, if you have invested in a mutual fund for the sole goal, for instance paying tuition fees for your kid, then IDCW is not a bad choice.

If you are a retired individual and need a periodic income to pay bills, it makes sense to invest in the IDCW option as this option tends to generate a regular income for you and also provides capital appreciation.

Please keep in mind that equity IDCW are risk prone and returns or dividend payout is dependent on market conditions. Consult a financial advisor if you are confused about whether the IDCW option fits your needs.

Taxation of IDCW Schemes in Mutual Funds

Income Distribution cum Capital Withdrawal (IDCW) schemes in mutual funds distribute some of your investment profits back to you. Before 2020, these dividends were taxed at the company level. Now, the income is taxed at the investor's rate. If your dividends exceed Rs. 5,000 per financial year, a Tax Deducted at Source (TDS) is applied. The change aims to prevent confusion about dividends being extra income. IDCW plans might not be as beneficial due to missed compounding and taxation disadvantages.

List of Best IDCW Mutual Funds in India 2024

Common Misconception about IDCW in Mutual Funds

IDCW is a facility that lets you earn regular income from your mutual fund investment. But some misconceptions are perpetually hanging like smoke in front of its benefits. Let us clear the air

Myth 1: Free Money

The IDCW payout is not extra income in addition to capital appreciation. It is from the invested capital itself. When an IDCW distribution is made to you, the Net Asset Value—or NAV—of the fund reduces by that much.

Myth 2: Guaranteed Income

IDCW payouts are not guaranteed. Amount dependent on fund performance may vary, and the Fund may not distribute income if it does not have sufficient profits.

Myth 3: Automatic Booking of Profits

Do not think that IDCW plans automatically book profits to pay dividends. It is based on the scheme's mandate; therefore, the fund manager makes a productive investment. Payouts can be from the dividend or capital gain.

Myth 4: All IDCWs Are the Same

Not true! Different IDCW options are available; Regular IDCW provides regular payouts, and Growth IDCW reins back your IDCW amount for its long-term potential growth. Choose based on your needs.

Understanding these common misconceptions will, therefore, help you make a better decision regarding IDCW in your mutual fund investments.

IDCW in Mutual Funds FAQs

Is there any difference between dividends declared by mutual funds and companies?

Yes, there is a key difference: corporate dividends are paid out of companies' profits, while mutual fund dividends represent the earnings of the fund itself, which may include company dividends, as well as interest and capital gains.

What does mutual funds IDCW mean?

IDCW stands for Income Distribution cum Capital Withdrawal. It refers to regular payouts from a mutual fund by way of dividends and some capital withdrawal.

What is better growth or IDCW?

Growth option aims for higher long-term returns by reinvesting earnings. IDCW offers regular income but potentially lower growth. Choose growth for long-term goals and IDCW for steady income.

What is IDCW reinvestment?

IDCW reinvestment takes your income distribution from the IDWC plan and puts it back into the plan to purchase more units. This increases your overall investment but does not provide immediate cash to you.

What is the dividend yield of Income Distribution cum Capital Withdrawal?

IDCW does not have a fixed dividend yield. Since it is a fund, the distributions are dependent on the performance and may consist of capital gains as well as dividends. Refer to the fund's historical distribution records for a better idea.

What is IDCW interim?

IDCW interim refers to partial income distributions made by a mutual fund throughout the year under the IDCW plan. It's part of the total payout you'll receive for that year.

What is IDCW payout in mutual funds?

An IDCW payout in mutual funds is a regular distribution of your investment's earnings. It can include dividends from stocks and some of your principal amount. It provides income but may reduce long-term growth compared to reinvesting earnings.