While selecting a mutual fund scheme, you must consider two critical parameters for suitability: Growth Plan and Distribution Cum Capital Withdrawal (IDCW) Plan.
Growth plans reinvest profits from stocks into the fund, while Income Distribution Cum Capital Withdrawal (IDCW) plans distribute the gains to investors at pre-determined intervals. Hence, investors should select a plan based on their individual financial goals, investment horizon, and tax slab.
Growth Plan
A mutual fund growth plan reinvests the profits earned from dividends and stock sales in the fund to drive growth. Kavitha Krishnan, senior analyst and manager of research at Morningstar India, says, "A growth plan is beneficial for investors who can remain invested and gain from long-term capital appreciation."
Advantages:
A growth plan has the advantage of a compounding effect since it reinvests the profits into the scheme, offering the potential to generate inflation-beating returns. Also, the fund house doesn't have to exit its stock positions to pay investors. Generally, growth plans have higher net asset value (NAV) than IDCW plans.
Disadvantages:
Growth plans do not provide regular income. You can only gain when you cash out the mutual fund units. But to achieve a substantial return on your investment, you will need to hold your investment long-term.
Tax
Growth plans have simple taxation rules. An investor must pay tax at the time of redemption of the mutual fund. Thus, growth plans attract short-term capital gains tax at 15 per cent if redeemed before a year, and long-term capital gains tax at 10 per cent (if earnings surpass Rs1 lakh in a fiscal year), if redeemed after three years.
Income Distribution Cum Capital Withdrawal (IDCW)
In IDCW schemes, gains are paid to investors at pre-determined intervals. For most IDCWs, it is paid annually, but they are also paid on a quarterly and monthly basis. "The plan is suitable for investors who prefer to receive regular income from their funds until they remain invested in it," said Krishnan.
The NAV of IDCW funds could decline as they distribute the profits at regular intervals. For example, "Suppose you own 5,000 units of a particular scheme with a NAV of Rs 20, and the fund announces a dividend of Rs 1 per unit. So, Rs 5,000 is paid to the investor as a dividend, paid from the investment, and the amount is taxed. On the date on which the dividend payout happens, the NAV of the scheme will drop by Rs 1 to Rs 19 from Rs 20. Hence, your fund value will be from Rs 1 Lakh to Rs 95,000," said Lovaii Navlakhi, managing director (MD) and chief executive officer (CEO) at International Money Matters.
Advantages
The IDCW plan benefits those looking for regular payouts, "Dividend (IDCW Payouts) income is added to your income tax; if you are in lower tax slab, you can get an advantage of lower tax," said Navlakhi.
Disadvantages
Whenever the fund's profits are distributed, the fund's NAV drops. People in the higher tax bracket will pay more tax as the payouts are counted as profits earned and added to the income and will be taxed as per the income tax slab. "This can dent the overall return that an investor generates by investing in an IDCW fund, especially if he/she falls in a higher tax slab," Krishnan added.
IDCW Tax
IDCW payouts are taxed as per your income tax slab. "Dividends from IDCW are taxed as per the individual's tax slab. So let's take the same example, if you are in the 30 per cent tax slab, you would have paid a tax of Rs1,500.
"Hence, your net dividend income would be Rs 3,500. If you had redeemed through growth, the capital gains would be considered either short-term or long-term gains tax. Either way, the tax rate is lower. Short-term is at 15 per cent, whereas the long-term is at 10 per cent. Also, the payout is not fixed in dividend options," said Navlakhi.
