What Is IDCW In Mutual Funds – Meaning, Full Form & Benefits

IDCW (Income Distribution cum Capital Withdrawal) mutual funds have become a widely talked-about investment option among Indian investors. Earlier known as dividend plans, these mutual funds have undergone regulatory changes that significantly impact their operational and perceptual aspects. Thus, this article delves into IDCW mutual funds, their working, the benefits, and key considerations for investors.

What is IDCW in a Mutual Fund?

IDCW, or Income Distribution cum Capital Withdrawal, is a mutual fund scheme wherein the fund periodically distributes profits to investors. These payouts are either derived from the income earned by the fund’s investments or from the withdrawal of a part of the invested capital. Unlike growth plans, which reinvest earnings, IDCW plans to focus on generating regular income for investors.

How Does Income Distribution cum Capital Withdrawal Work?

The two basic sources of working of IDCW mutual funds are:

• The portfolio of the fund earns money through interest, dividends, or capital gains. This amount is distributed among investors at specific intervals.

• If income is insufficient to meet the declared payout, a part of the investor’s capital is utilized to meet the distribution requirement.

• The NAV of the fund decreases with each payout as the reduction in assets is reflected.

Types of IDCW in Mutual Funds

The IDCW plans of mutual funds can vary in terms of the frequency of income distribution. There are:

1. Daily IDCW: Income is distributed daily, which is ideal for investors seeking constant cash flows.

2. Weekly IDCW: Distributions take place weekly, balancing liquidity with slightly higher returns.

3. Monthly IDCW: Popular among retirees, monthly payouts provide a steady income stream.

4. Quarterly or Annual IDCW: Designed for long-term investors who prefer infrequent but larger payouts.

Each type caters to different investor needs based on financial goals and cash flow requirements.

What is SEBI’s New Rule on Dividend Plans?

As of April 2021, SEBI also decreed that the names of dividend plans should be changed to Income Distribution cum Capital Withdrawal (IDCW) plans. This move was primarily to:

Increase transparency about the nature of distributions.

Educate investors that payout is not only income but includes a portion of the amount invested.

Reduce misconception arising from the word “dividend,” which created many misconceptions in the minds of investors that payout is pure profit.

Why did SEBI Rename Dividend Plan as Income Distribution cum Capital Withdrawal Plan?

SEBI needed to rename dividend plans for one reason: clarity and elimination of ambiguity for investors. There were a few reasons why it actually happened:

• The word “dividend” suggested that it always came from profit. By renaming it to IDCW, SEBI ensured there was no ambiguity among the investors about whether capital withdrawal may feature in the payout.

• Many investors were not aware of the implications of such payments on NAV. The new terminology helps people make informed choices.

• The term aligns with international standards and underlines the dual nature of payouts.

Things Investors Should Know Before Choosing the IDCW Plan

Before choosing an IDCW plan, investors should remember the following:

1. NAV Decline: Each payout reduces the fund’s NAV, affecting the overall growth of the investment.

2. Tax Implications: IDCW distributions are taxable as per the investor’s income slab, potentially impacting net returns.

3. Suitability: These plans are ideal for those requiring regular income, such as retirees, but might not be the best choice for long-term wealth creation.

Who Should Invest in the IDCW Plan?

IDCW (Income Distribution cum Capital Withdrawal) plans are especially beneficial for those with periodic needs of income over capital growth. Thus, even due to the requirement of income frequency, IDCW plans shall be chosen often by:

• Retirees: These are people who have retired and no longer work. They require a steady flow of income to sustain their monthly expenses. IDCW plans to provide a steady source of cash flow, ensuring retirees can maintain their lifestyle without dipping into their principal investments.

• Conservative Investors: They want stability more than the prospect of growth due to reinvestment. A conservative investor requires predictability. The IDCW scheme will appeal more to such a person, whose main concern would be predictability and lower exposure to risk.

• Income-Oriented Investors: People with periodic financial liabilities like education charges, EMI, or other monthly expenses. IDCW plans to provide a regular cash flow for income-driven investor to meet their commitments without much financial strain.

It has been possible to generate income and preserve capital, as IDCW plans are offered; hence, for investors seeking returns for consistent and constant financial goals, it is the best choice.

Advantages of Income Distribution cum Capital Withdrawal

IDCW mutual funds have the following benefits:

• Regular Income: These plans ensure regular cash flows, making them ideal for income-oriented investors.

• Flexibility: With the number of payout frequencies, IDCW plans can be made flexible to meet the requirements of different investors.

• Accessibility: They enable investors to realize market gains without the requirement of redemption of units.

Comparison Between Dividend Declared by Companies and IDCW from Mutual Funds

The two concepts involve payouts; however, there are some significant differences:

• Source: Corporate dividends originate only from profits. Payouts under IDCW can come from both profits and capital.

• NAV Impact: IDCW payments lower the NAV of mutual fund units, but company dividends do not directly affect the stock price.

• Taxation: Company dividends are subject to DDT, whereas the IDCW payouts are subject to the investor’s income slab.

• Nature: The company dividends indicate the profitability and health of the business, but the IDCW payouts are not necessarily an indicator of a fund’s performance.

Taxation of IDCW Schemes in Mutual Funds

The taxation of IDCW schemes has a significant impact on the net returns of investors:

• Taxable Income: Dividends received by investors are taxable as per their individual income tax slab.

• Tax Deducted at Source (TDS): TDS may apply to IDCW payouts if they exceed a certain threshold.

• Double Taxation Misconception: There is no double taxation, as IDCW plans do not pay DDT; investors bear the tax liability directly.

Investors should consider the tax implications before selecting IDCW plans, especially if they fall under higher tax brackets.

IDCW vs SWP: Which One Should You Choose?

Investors usually receive regular income through mutual funds from IDCW and SWP. Understanding what is different about the two will help an investor make the right choice.

IDCW is the periodic payment of profits by a mutual fund. The payouts are based on the performance of the fund and are not assured. Although IDCW provides an income stream, it is less tax-efficient due to DDT, especially for investors in higher tax brackets. Also, the payout reduces the NAV of the fund, meaning the capital available for future growth is reduced.

SWP, however, enables investors to withdraw a fixed amount at regular intervals. Unlike IDCW, SWP is more flexible because you are in control of the amount and timing of withdrawal. In SWP, the entire withdrawal amount is considered taxable income. However, the tax liability is calculated on the capital gains portion of the withdrawal, which is the difference between the purchase price and the selling price of the units redeemed. In addition, SWP withdrawals do not depend on market performance; they are stable and predictable.

SWP is the better choice for most investors because it is flexible, tax-efficient, and preserves investment growth. IDCW may be suitable for those who want occasional payouts but is less reliable for consistent income.

Difference Between Dividend Declared by Companies and IDCW from Mutual Funds

Though both the dividends declared by companies and IDCW in mutual funds provide periodic payouts to investors, they differ in nature and have significant implications.

A dividend is a portion of a company’s profit shared among its shareholders as a form of reward for their investment. The board of directors declares it, and it is paid from the current or retained earnings. Dividends represent profitability and the sound financial health of a company. An investor taxes it based on their income tax slab. Significantly, dividend payment does not have a direct influence on share price since share prices remain contingent on the performance in the market.

IDCW in a mutual fund is not entirely a profit share. It encompasses income obtained by the fund, which could be in terms of dividends, interest, or capital gains, and, at the same time, involves partial withdrawal of invested capital. Based on the fund’s performance, IDCW is declared. There is no guarantee that the payments can be received periodically. Upon the payment of IDCW, there is a reduction in the NAV of the mutual fund by an amount equivalent to the amount paid.

Whereas dividends represent a company’s profitability, IDCW is a redistribution of mutual fund assets and thus depends on the fund’s structure and tax policies.

IDCW in Mutual Funds – The Procedure to Follow

The process of IDCW is very systematic with proper fund management:

• Earnings Evaluation: The fund manager calculates the income from the portfolio.

• Payout Declaration: Depending on the earnings, the fund house declares the payout for IDCW.

• Capital Withdrawal: A share of the capital tops up the payout in case income falls short.

This allows the fund to maintain its objective and income distribution.

Conclusion

IDCW mutual funds are a good investment for income-seeking investors. Funds are also quite suitable for retirement schemes, investments by conservative investors, or financing specific financial targets that require predictable cash flows. Nonetheless, some nuances need to be understood, for example, in terms of taxation, which affects returns, and in terms of the reduction in NAV in an equivalent amount distributed. While IDCW plans are suitable for income-focused goals, growth plans are often better for long-term wealth creation. Personal financial needs and investment goals must be assessed before making a decision.

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