Turn Mutual Funds Into Monthly Income (Part 1 - Stocks Give Dividends, Mutual Funds Have IDCW)

What is IDCW?

IDCW is an option in mutual funds that distributes a portion of the fund's earnings to investors, as periodic payouts. This option was previously called the "dividend option" as per SEBI norms; but was renamed to avoid confusion. Unlike stock ‘dividends’, IDCW payouts may not always from profits and can include a part of the investor's own capital – hence the change in nomenclature.

While IDCW gives regular income, it can lead to a lower Net Asset Value (NAV) and reduced compounding compared to a growth option. 

Who is IDCW suitable for?

• Investors who need regular cash flow, such as retirees and professionals with lumpy and volatile earnings.

• Individuals with short-term financial goals and / or who need periodic liquidity. 

How does IDCW work?

• Payouts: The fund manager distributes earnings, which come from the fund's earnings (like dividends from stocks or capital gains), to investors. Dividend paid by a mutual fund scheme is not just dividend received from underlying stocks but also from capital appreciation.

• Capital withdrawal: A part of the payouts may come from your initial investment, which reduces the total value of your investment.

• Frequency: Payouts are not guaranteed and can be monthly, quarterly, or annually, depending on the fund's performance and the fund manager's discretion.

• NAV Adjustment: Every payout reduces the NAV of the fund by a corresponding amount - because the money leaves the scheme and reaches the investor.

  Example:

  Particulars	Amount
  Investment value in MF scheme [A]	₹10,000
  Units of MF Scheme (Nos.) [B]	1,000
  NAV [A] / [B]	₹10
  IDCW Payout per Unit [C]	₹0.5
  Total IDCW Payout [D] = [C] * [B]	₹500
  Investment value post IDCW payout [A] - [D]	₹9,500
  NAV (post IDCW Payout)	₹9.5

What are the payout options under IDCW for investors?

• Payout into the investor's bank account

• Re-investment in the same scheme, resulting in additional units

• Transfer to other schemes of the fund house. As investors reach closer to their retirement, they may want to transfer some of their corpus from existing equity schemes to lower risk equity, hybrid or debt schemes*

  * this can also be done through a Systematic Transfer Plan (STP), but the tax implications may differ from IDCW.

Things to keep in mind

• Payouts not guaranteed: The amount and frequency of payouts depend on the fund's performance and the fund manager's decision, so income is not fixed.

• Limitation in compounding: This option is less ideal for long-term wealth creation because the regular payouts prevent the benefits of compounding to fully work out.

• Tax implications: IDCW payouts are added to your total taxable income and taxed according to your individual income tax slab rate. If total dividend income exceeds Rs5,000 in a financial year, TDS is deducted by the fund at the rate of 10%.

• Alternative option: For those in higher tax brackets seeking regular income, a Systematic Withdrawal Plan (SWP) might be a more tax-efficient alternative (capital gains tax rate vs 30% slab rate) and also ensure predictable payouts. We cover SWPs in greater detail in Part 2 of this series - Turn Mutual Funds Into Monthly Income (Part 2 - Systematic Withdrawal Plans - Reverse SIPs).

IDCW is a good option for investors requiring regular income (at the cost of compounding). We, at Creso, encourage distributors to thoroughly evaluate IDCW and growth option for suitability to clients and explore Creso - Powering India's Next-Gen Mutual Fund Distributors as a credible partner in their wealth creation journey.