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What us IDCW in mutual funds? How Does the IDCW Mutual Fund Work?

IDCW in Mutual Funds:
Income Distribution cum Capital Withdrawal or IDCW refers to distribution of income of a mutual fund scheme, which may include both dividends paid by stocks and capital gains made by selling underlying stocks from the scheme portfolio.

Noteworthy points for IDCW funds:
  • SEBI mandates that dividends can be paid out only from profits earned by the respective mutual fund.
  • Dividend payout rates may vary with each payout cycle.
  • Dividends paid on both equity and debt mutual funds are taxed as per the investor’s income tax slab. In case the investor doesn’t have any source of income other than mutual funds, a mandatory TDS is deducted at 10% from the total dividend income. However, no deduction takes place if the dividend distributed is Rs. 5000 or lower.
The dividends are gains that an investor receives over and above his investment. However, this wasn't the case in mutual funds. While the investor receives profits, known as dividends, at the same time, the NAV of his investment gets reduced by the same amount. In reality, there is no gain or additional payout. It's like withdrawing money from your capital. Therefore, SEBI decided to rename the gain as 'distribution', as it always was in reality. The IDCW meaning in mutual funds is the same as what dividend meant before. This name change is solely for clarity.
Investors are unaware of the difference between income distribution and capital distributions when it comes to mutual funds. The former indicates an appreciation of NAV, whereas the latter indicates the amount in equalisation reserve or investor's capital.
When units are sold at a higher price than their face value, realised gains are transferred to a separate account called the equalisation reserve account. Dividends are paid from this account.
How Does the IDCW Mutual Fund Work?
We have established above that mutual fund dividends are only the amount of capital appreciation paid from the investor's capital; hence the reason for changing the name from 'dividend plan' to a more accurate 'income distribution plus capital withdrawal (IDCW) plan'. Let's explain this with an example.
  • A unit-holder owns 5000 units of a dividend or IDCW mutual fund scheme, and the NAV of the fund is Rs 10. This NAV is inclusive of dividends. Consequently, the total investment value of the unit-holder is Rs 50,000.
  • Let us say that a mutual fund declares a dividend of Rs 2. As a result, the unit-holder is entitled to receive Rs 10,000 (Rs 2 * 5000 units) as a dividend or IDCW. This amount will be credited to the investor's capital account or equalisation reserve with the fund.
  • If the unit-holder redeems this amount, the NAV excluding dividends comes to Rs 8 (10-2). Thus, the total investment is Rs 40,000 (Rs 8*5000 units).
  • If we compare the before and after dividend payout scenarios, the investor receives Rs 50,000 in both cases. Hence, nothing changes. Thus, we can say that the investor withdrew Rs 10,000 from his capital only.
  • In contrast, if the investor had invested in a growth option scheme, there would have been no dividend payout, and their capital would have remained intact.
  • An investor's IDCW income is added to their gross taxable income and taxed following their tax slab. Furthermore, if the investor's total dividend exceeds Rs 5000, they will be subject to TDS.

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