How IDCW in Mutual Funds Works and Who Should Opt for It?

When you invest in mutual funds, you may come across the term IDCW. For many new investors who are learning about the different types of Mutual Funds, this term can be confusing. Understanding what it means, how it works, and whether it suits your financial goals is beneficial before making any investment decisions.

This blog will help you clearly understand IDCW in Mutual Funds, how it differs from other options, and who should ideally opt for it.

What is IDCW in Mutual Funds?

The term IDCW in Mutual Funds stands for Income Distribution cum Capital Withdrawal. It is the new name for what was earlier known as the "Dividend Option" in mutual funds. The SEBI introduced this terminology in 2021 to make the functioning of such plans more transparent for investors.

To put it in simple terms, when you invest your money into a mutual fund scheme with the IDCW option, the fund periodically distributes a part of its profits to investors. These payouts are made from the distributable surplus of the scheme, which may include realised profits and a portion of the capital. It means, if you choose an IDCW fund, you receive regular income in the form of cash payouts (or reinvestments) instead of keeping all your returns invested within the scheme.

How IDCW in Mutual Funds Works

The IDCW option is the fund manager's decision on when and how much income to distribute. However, it's important to remember that IDCW payouts are not guaranteed. They depend entirely on the fund's performance and the availability of distributable surplus. Here's how the process works step by step:

• Generation of Profits: The mutual fund earns income from its investments through dividends, interest, or capital gains.
• Declaration of IDCW: Based on this performance, the fund house may decide to distribute a portion of the surplus to investors.
• Payout or Reinvestment: Investors can choose to either receive the IDCW amount directly in their bank account or reinvest it in the same scheme to buy additional units.
• Impact on NAV: Once the IDCW amount is paid or reinvested, the Net Asset Value (NAV) of the scheme changes by the same amount, as funds are withdrawn from the scheme's total assets.

Thus, IDCW in Mutual Funds doesn't provide additional profit; it is merely a distribution of what's already earned within the fund.

Taxation on IDCW in Mutual Funds

Earlier, dividends from mutual funds were tax-free in the hands of investors, and the fund house paid a Dividend Distribution Tax (DDT). However, since April 2020, the taxation structure has changed.

Now, IDCW in Mutual Funds is added to your total income and taxed according to your applicable income tax slab. Additionally, if the total IDCW payout surpasses ₹5,000 in a financial year, the AMC deducts 10% Tax Deducted at Source (TDS) before distributing the income. Hence, if you fall under a higher tax bracket, opting for an IDCW plan might not be as tax-efficient as a growth plan.

Who Should Opt for IDCW in Mutual Funds?

Investing is about the time, risk tolerance and capital you have. This is why not every investor benefits from choosing an IDCW option. It depends on your financial needs. Here's who may find it suitable:

• Retirees and Senior Citizens: Those looking for regular income from their investments may find IDCW in Mutual Funds useful to meet monthly or quarterly expenses.
• Conservative Investors: Individuals who prefer periodic returns instead of waiting for long-term appreciation can consider this option.
• Short-Term Goal Seekers: If your investment horizon is short and you need regular payouts to fund ongoing expenses or smaller goals, an IDCW plan might suit your needs.

However, if your aim is long-term capital appreciation, the growth option generally proves more effective because of compounding benefits. Read our blog on how to decide what is best between growth and dividend mutual funds for your financial goals.

Advantages and Disadvantages of IDCW in Mutual Funds

Advantages:

• It offers a source of regular income.
• It provides flexibility with payout or reinvestment options.
• It is suitable for conservative investors who prefer cash flow stability.

Disadvantages:

• Payouts are not guaranteed and depend on fund performance.
• Reduces NAV after each distribution.
• May not be tax-efficient for investors in higher tax brackets.
• Limits the compounding effect compared to the growth option.

If you understand the pros and cons, you can make an educated decision before opting for your best IDCW mutual funds to add to your portfolio.

Things to Consider Before Choosing an IDCW Option

• Assess your financial goals: IDCW is suitable for income-oriented investors, not for long-term capital growth.
• Evaluate taxation: You should understand how IDCW payouts affect your overall tax liability.
• Check consistency: Look for funds with a steady track record of returns rather than just frequent IDCW declarations.
• Understand the reinvestment impact: Reinvested IDCW is treated as a fresh investment and subject to taxation upon redemption.

When you keep these aspects in mind, you can choose the best IDCW mutual funds based on your financial requirements and risk profile.

Conclusion

IDCW in Mutual Funds offers a way to earn periodic income from your investments while staying invested in the market. It is best suited for investors who prioritise regular cash flows over capital appreciation. However, understanding how IDCW works, its tax implications, and its impact on NAV is vital before choosing this option.

If your goal is long-term wealth creation, then a growth option may be better suited for you as it benefits from compounding. But for those seeking regular income, like retirees or conservative investors, an IDCW fund can be a practical choice when selected carefully. To explore how different mutual fund options align with your financial goals, visit the Mutual Funds section on the Indiabulls Securities Limited (formerly known as Dhani Stocks Limited) website.

Disclaimer

Mutual fund investments are subject to market risks, read all scheme related documents carefully.

FAQs

1. How often is IDCW paid in mutual funds?

The frequency of IDCW payouts varies across schemes. Some funds may pay monthly, quarterly, or annually, depending on the fund's policy and availability of distributable surplus.

2. Does IDCW reduce my mutual fund returns?

Yes, the Net Asset Value (NAV) of your scheme decreases by the payout amount after every IDCW distribution since it comes from the scheme's assets.

3. Can I switch from IDCW to the Growth option?

Yes, you can switch from IDCW to Growth by submitting a switch request to your fund house or through your investment platform. However, taxation and exit load may apply.

4. Is IDCW a fixed-income option?

No. IDCW is not guaranteed and depends entirely on the mutual fund's performance and the fund manager's discretion.