What Happens to the Dividends (Income Distribution cum Capital Withdrawal (IDCW)) Received By a Mutual Fund schemes?

Mutual fund schemes have become a popular investment vehicle for many Indian investors, including those in Tier II and Tier III cities (Tier II and Tier III cities in India are the smaller urban centre’s experiencing growth and development , having population of Tier II cities range between 50000 to 99999 and Tier III cities range between 20000 to 49999 ). They offer a diversified portfolio managed by professionals, making them an attractive option for those looking to grow their wealth. One common question that arises among mutual fund investors is about dividends: "Do mutual fund schemes give dividends?", "What happens to the dividends received by a mutual fund schemes?", and "Do mutual fund schemes pay dividends?" Let's delve into these queries and understand the role of dividends in mutual fund schemes.

Mutual fund schemes pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities. When these investments generate income, such as dividends from stocks, the mutual fund schemes receive these dividends. But what happens next? How are these dividends handled, and what options do investors have?

Understanding Dividends in Mutual fund schemes

Dividends are payments made by companies to their shareholders from their profits. In the context of mutual fund schemes, dividends are the income earned from the schemes investments in dividend-paying stocks. These dividends are a part of the returns generated by the mutual fund schemes and contribute to the overall performance of the fund.

For example, if a mutual fund schemes holds shares of a company that pays a dividend, the mutual fund schemes will receive a portion of that dividend based on the number of shares it holds. This income is then distributed to the mutual fund schemes investors or reinvested, depending on the schemes dividend policy, plan selected by the investor and the investor's choice.

How Mutual fund schemes Handle Dividends

Mutual fund schemes handle dividends in two primary ways: reinvestment and distribution.

1. Dividend Reinvestment:

• In case of Dividend Reinvestment option, you can reinvest the dividend made by the scheme during the intermediate period back into the scheme.
• Reinvesting dividends allows investors to buy more units of the mutual fund schemes without having to invest additional money. This can lead to compounding returns over time, as the reinvested dividends generate their own income.
• For example, if you hold units in a mutual fund schemes that pays a dividend, and you choose the reinvestment option, the dividends you would otherwise receive will be used to buy more units of the scheme. This increases your total holdings and can enhance your long-term returns.

2. Dividend Distribution:

• Alternatively, mutual fund schemes can distribute the dividends received to their investors in the form of cash payments. This is known as dividend distribution.
• Investors who choose this option receive the dividends as regular income, which they can use for their financial needs or reinvest elsewhere.
• For instance, if you hold units in a mutual fund schemes that pays a dividend, and you choose the distribution option, you will receive the dividends as cash payments, which can be credited to your bank account.

Tax Implications of Dividends in Mutual fund schemes

Understanding the tax implications of dividends received from mutual fund schemes is crucial for investors. In India, the tax treatment of dividends varies based on the type of mutual fund schemes. The taxes on gains on mutual fund is treated as capital gain (long term or short term depending on the period of holding). For better understanding and updated tax legislations, you are recommended to consult to a tax advisor.

1. Equity Mutual fund schemes:

• Dividends received from equity mutual fund schemes are subject to Dividend Distribution Tax (DDT). However, as of April 2020, DDT has been abolished, and dividends are now taxed in the hands of the investors.
• Investors must include the dividends received in their total income and pay tax according to their applicable income tax slab rates.

2. Debt Mutual fund schemes:

• Dividends received from debt mutual fund schemes are also taxed in the hands of the investors. The tax rate depends on the investor's income tax slab.
• It is essential to consider the tax implications when choosing between dividend reinvestment and distribution options.

Factors to Consider When Choosing Dividend Options

When deciding between dividend reinvestment and distribution, investors should consider several factors:

1. Investment Goals:

• If your goal is long-term wealth accumulation, reinvesting dividends can help you benefit from compounding returns.
• If you need regular income, opting for dividend distribution may be more suitable.

2. Financial Needs:

• Consider your current financial situation and liquidity needs. If you require cash flow for expenses, dividend distribution can provide regular income.
• If you do not need immediate cash, reinvesting dividends can help grow your investment over time.

3. Tax Considerations:

• Evaluate the tax implications of dividends based on your income tax slab. Reinvesting dividends may defer tax liability, while receiving dividends as cash may result in immediate tax obligations.

4. Market Conditions:

• Market conditions can influence your decision. During market downturns, reinvesting dividends can help you buy more units at lower prices, potentially enhancing future returns.

Conclusion

Dividends play a significant role in the returns generated by mutual fund schemes. Understanding how mutual fund schemes handle dividends and the options available to investors is essential for making informed investment decisions. Whether you choose to reinvest dividends or receive them as cash payments, consider your investment goals, financial needs, and tax implications. By staying informed and making educated choices, you can maximize the benefits of your mutual fund scheme investments.

By understanding the nuances of dividends in mutual fund schemes, investors can make informed decisions that align with their financial goals and maximize their investment returns.

Additional links

What is a Mutual Fund? - Beginner's Guide to Investing

AMFI - Introduction to Mutual Funds

Know everything about SIP

What is Mutual Fund Dividend?

Let’s Learn How to Invest in Securities Market

Dividend Reinvest Option