IDCW in Mutual Funds and How Does it Work?

In India, mutual funds are one of the most frequent investment instruments, and several schemes cater to different investor needs and risk profiles. The ability to convert dividends into regular income is one of the main characteristics of a fund. The fund can deliver income or capital gains returns when an investor invests in a Mutual Fund. The income mutual funds receive regarding the underlying assets, for example, dividends, interest and rental revenues, is regarded as a distribution to investors. Mutual funds shall be deemed to have made capital gains when they sell their underlying assets at a higher price than the amount paid.

IDCW, “Income Distribution cum Capital Withdrawal” in mutual funds, refers to a payment option where investors get regular payouts of a share of the fund’s income plus capital gains. These payments can be made monthly, quarterly, half-yearly, or annually, depending on the nature of the Fund.

So, let’s move ahead in this article and understand IDCW’s meaning in detail.

Understanding IDCW Meaning in Mutual Funds

When investing in a mutual fund, you will have two options: growth and dividends. The basic portfolio is the same, regardless of which option you choose. However, how profits are divided between schemes is a differentiating feature of these options. You can receive dividends from your investments at regular intervals in the dividend option, now known as IDCW, or you can receive capital appreciation in the growth option.

Given that there is a widespread misconception that mutual fund dividends are additional returns from the profit earned by the scheme above and beyond the capital appreciation they are earning from the scheme, the Securities and Exchange Board of India (SEBI) changed the naming system from “dividend” to “income distribution cum capital withdrawal plan.” Indeed, investors continue to hold this misperception.

To better reflect its genuine meaning, SEBI changed the “dividend” option to “income distribution cum capital withdrawal (IDCW)”. A portion of the income given by mutual fund schemes consists of dividends earned and capital gains recorded due to the sale of underlying securities.

Simply put, the income that individuals mistakenly think of as dividends is earned through investor value, which is the same as a capital withdrawal. If you’ve noticed, this explains why, every time a mutual fund scheme pays out a dividend (formerly called an IDCW), the scheme’s net asset value (NAV) proportionally decreases and is readjusted.

Reason For Changing the Dividend Nomenclature to IDCW by SEBI

In India, SEBI is the regulatory body overseeing and regulating mutual fund schemes, including those under IDCW. The agency will take several actions to increase investor convenience and transparency in the capital and secondary markets. One such investor-friendly measure is the renaming of dividends to IDCW.

It has become mandatory for India’s top 100 listed companies with high market capitalization to set up a dividend distribution policy due to SEBI’s changes to the rules on IDCW in mutual funds. In addition, the dividend distribution policies of other companies may be disclosed and published on their websites. SEBI has changed the LODRs, or listed obligations and disclosure requirements, and given clear instructions for setting up a Risk Management Committee.

In the old days, dividends were paid inversely to net asset value. Consequently, the scheme’s net asset value decreased proportionately to the dividend value each time a mutual fund house declared and paid dividends. Consequently, since the decrease in capital allowed withdrawals, the investor would not have earned any additional income. The dividends, however, should, in essence, represent an additional source of income for the investors. SEBI subsequently redefined the dividend schemes as IDCW, or Income Distribution and Capital Withdrawal Schemes.

Investors now have a deeper understanding of the structure of these schemes, even if the rebranding did not alter how they operate. In IDCW, Capital Withdrawal refers to the investor’s capital or the equalisation reserve amount, and Income Distribution refers to NAV growth. When units are sold for more than their face value, a mutual fund manager deposits the realised profit into an equalisation Reserve Account and pays dividends.

The name change will aim at promoting transparency and helping investors make informed decisions. In the present case, AMCs shall state the investment objective and methodology of these IDCW schemes in all mutual fund offer documents for such schemes.

Taxation of IDCW Schemes in Mutual Funds

Previously, a dividend tax of 15 % was to be paid by companies before disbursing dividends. But, according to the Finance Law 2020, investors are obligated to pay tax on dividends resulting from IDCW schemes in pooled investment vehicles. However, you don’t have to pay taxes if your dividend income isn’t more than INR 1 Lakh for a financial year.

It is also advisable to be aware that TDS (Tax Deducted at Source) is deducted from profits by AMCs. TDS will only be removed from your dividend payments if they total more than INR 5,000 in a fiscal year.

IDCW or Growth – Which Mutual Fund Scheme is Better?

In India, investors can invest in growth or an IDCW scheme. If you are an investor looking for a longer-term investment and want to make your dream come true, you can choose the Growth option. Because of the absence of frequent withdrawals from growth funds, managers can choose to use those funds in the best interests of investors. However, it is better to choose an IDCW scheme if you want regular income, but you may not be able to take advantage of compound interest.

Growth investors are subject to two types of taxes: the Long-Term Capital Gains (LTCG) Tax and the Short-Term Capital Gains (STCG) Tax. In contrast, investors in an IDCW scheme must pay three different types of taxes: dividends, LTCG, and STCG.

Conclusion

As an alternative to conventional instruments such as fixed deposits or sovereign savings schemes, investors could be encouraged to invest in IDCW mutual funds. The Share India trading platform provides an inventory of the largest IDCW schemes in India, which is easy for users to access. You can access a list of the most successful schemes and add documents such as a PAN or Aadhar card to set up an account. Before investing, ensure that the documents of the scheme are read carefully.