what is IDCW in mutual fund

Origin of IDCW in Mutual Funds

Ever thought about investing in mutual funds but also want to withdraw your profits periodically? If yes, then the IDCW option in mutual funds could be a great choice for you!

One important thing to keep in mind is that you need a sizable corpus to invest in the IDCW scheme. If you're still building your corpus through SIPs, this scheme may not be useful for you at this stage.

IDCW or Income Distribution cum Capital Withdrawal (IDCW) plan was introduced by the Securities and Exchange Board of India (SEBI) in April 2021 . It was previously known as a “dividend option” in mutual funds, which simply paid out profits. However, today's IDCW funds offer various payment options, leading to the change in name.

In this article, I will dive deeper into IDCW in mutual funds and provide insights into various aspects, including what it is, its benefits, how it works, and whether you should invest in it. So, let's start with the first point

What is IDCW in Mutual Fund ?

IDCW, or Income Distribution cum Capital Withdrawal, is a feature in mutual funds that allows investors to receive periodic payouts from their investments. These payouts are derived from the distributable surplus of the mutual fund scheme. 

If a mutual fund has a monthly IDCW payout, the amount you receive will depend on the fund's performance.If the fund performs well in a given month, you'll receive a higher payout. However, if it underperforms or generates negative returns, the payout will come from your invested corpus, which, over time, can reduce the base on which future profits are earned. This is the basic idea of how the IDCW scheme works in mutual funds.

Now lets talk about the benefits or why should you invest in it 

Benefits of IDCW in Mutual Funds

The IDCW scheme in mutual funds is ideal if you're looking for liquidity or you want to book profits periodically and prefer taking risks  or need a regular income. If any of the following  align with your goals, you can consider investing in IDCW mutual funds.

Some of the Benefits are:-

Regular Income Stream - Provides periodic payouts (monthly, quarterly, or annually) to meet expenses.

Flexibility in Capital Withdrawal - Allows partial withdrawals (only on the profits) without fully redeeming investments .

Tax Efficiency-IDCW is taxed at the investor’s applicable tax slab, which will be beneficial for you , if you are in the lower tax bracket plus no capital gain tax on this . I have discussed this in detail in the later part of this article.

After reading about the benefits, you might be thinking that IDCW sounds a lot like the SWP scheme in mutual funds. Let me clear up that confusion .

IDCW vs SWP 

Both schemes require a sizable corpus to start with. If you haven’t built one yet, check out our article on how to grow and build your corpus. Check out the table below to understand the key differences between the two.

In conclusion, if you want to periodically book profits from your mutual funds, IDCW is a great option. However, if you prefer a fixed periodic income, SWP would be the better choice. After clearing the difference between the two , lets look into how IDCW in Mutual Funds Work 

How IDCW in Mutual Funds Works

IDCW, or Income Distribution cum Capital Withdrawal, allows you to receive periodic payouts from your mutual fund investments. There is broadly 3 steps:-

1. Income Generation

Mutual funds generate income from dividends on stocks, interest from bonds, and capital gains from selling securities. This income accumulates as a distributable surplus, which is periodically shared with investors.

2.Payout Declaration

The fund manager evaluates earnings and determines how much to distribute as IDCW.The payout is calculated based on the fund’s Net Asset Value (NAV) and the investor’s holding period. The investor has no role to decide the amount of payout or the cyclicity of the payout.

3. Capital Withdrawal

If the income generated is insufficient to cover the declared payout, a portion of the investor’s principal (capital) is withdrawn to meet the distribution . As a result, the NAV decreases after each payout, reducing the overall value of remaining units. Taxes as per the Investor’s Income Tax Slab will be charged on the dividend amount.

Now with an Help of an Example, Lets understand the working in a better way 

Example of How IDCW Works in Mutual Funds?

To illustrate how Income Distribution cum Capital Withdrawal (IDCW) functions, let's consider a hypothetical mutual fund investment scenario.

At the start of the IDCW scheme, you have ₹1 lakh, and the NAV of the mutual fund you are considering is ₹100 per unit. After investing, you purchase 1,000 units of that mutual fund. Now, after a year, the mutual fund’s NAV has increased to ₹110 per unit, and the fund has decided to distribute ₹2 per unit as a payout. This means you will receive a payout of ₹2,000. However, after the payout, your NAV will not remain ₹110 per unit; it will decrease to ₹108 per unit. As a result, your remaining corpus will be ₹1,08,000, which will be used to generate future profits.

This scenario seems favorable, but problems arise when the payout does not match the growth. Let’s revisit the same example with some minor changes.

You invest ₹1 lakh, and the NAV of the mutual fund at the time of investment is ₹100 per unit, giving you 1,000 units. After a year, the NAV decreases to ₹98 per unit, but the mutual fund still decides to distribute ₹2 per unit as a payout. This means you will still receive ₹2,000, but now, after the payout, your NAV will drop further to ₹96 per unit. As a result, your remaining corpus will be ₹96,000. Since your corpus has decreased, your future profits will also be lower, and the power of compounding will be significantly weakened.

This is why IDCW is not an ideal investment option—it neither provides a stable income like SWP nor allows compounding to work effectively as Growth Mutual Funds. Though there are Dividend IDCW mutual funds that do not pay out from the corpus, they simply do not distribute payouts if there are not enough profits to disburse. To learn more, let's now discuss the different types of IDCW mutual funds.

Types of IDCW Mutual Funds Plans 

IDCW (Income Distribution cum Capital Withdrawal) offers different options to meet various investor preferences. Below are the main types:

If you look at the different types of IDCW mutual funds, the Regular IDCW option is similar to SWP, but due to taxation, SWP may be a better choice (I’ll discuss this later). The Growth IDCW option isn’t really an IDCW—it works just like a normal Growth mutual fund. The Dividend IDCW option is the most true to IDCW’s purpose. It doesn’t deplete your corpus and simply pays out the profits periodically, making it a good option to consider.

Now lets Discuss about the TAXES in IDCW in Mutual FUNDS ?

Taxes on IDCW mutual funds are based on the investor’s tax bracket. If you fall into a lower tax bracket, this scheme may be beneficial for you. However, if you belong to a higher tax bracket, IDCW is not a favorable option. This is the primary reason why many investors prefer SWP over IDCW.

SWP is a better option for individuals in higher tax brackets because it is taxed only on capital gains, rather than the entire payout. Additionally, SWP benefits from an exemption of up to ₹1 lakh in profits. This makes SWP a more tax-efficient choice for those seeking regular income.

Example:

Suppose you are in a higher tax bracket and are required to pay 30% tax. In the case of IDCW, the entire payout will be taxed at 30% with no exemptions. However, if you had invested in an SWP scheme, the withdrawal would be subject to a capital gains tax of up to 20%, and only on the profits, with an exemption of up to ₹1 lakh.

I hope this explanation clarifies the taxation differences and helps you understand who should consider investing in IDCW plans.

Who Should Invest in IDCW Plans?

I believe IDCW plans are best suited for people who prefer lower risk, want to book profits periodically, and fall into lower tax brackets.

I wouldn’t recommend IDCW plans for those seeking regular payouts, as SWP is a better option with added tax benefits.

Additionally, IDCW is not ideal for individuals in higher tax brackets since the payouts are taxed according to their applicable tax rate.

lets talk about the Demerits Now 

Demerits of IDCW in Mutual Funds

While IDCW plans offer regular income and liquidity, they come with several drawbacks that investors should carefully consider before opting for this investment strategy.

Reduced Capital Appreciation- Regular payouts reduce the fund’s Net Asset Value (NAV), limiting its growth potential and affecting long-term capital appreciation. Since IDCW distributions are not reinvested, investors miss out on the power of compounding, which could have significantly increased their wealth over time.

Tax Implications

Higher Tax Burden: IDCW payouts are taxed at the investor’s applicable income tax slab rate, which can be unfavorable for those in higher tax brackets and there are no exemptions also which again make it an unfavourable scheme to invest in.

Conclusion on IDCW in Mutual Funds

IDCW might seem like a good option because it gives regular payouts, but it has some major downsides. The payouts aren’t fixed, they depend on how the fund performs. Plus, every time you get a payout which does not match with the profits earned , your investment value goes down, which means you’ll have a smaller base to earn future profits. On top of that, the tax on IDCW is based on your income slab, so if you’re in a higher tax bracket, you’ll end up paying more tax.

That’s why most people prefer SWP—it gives more control, is more tax-friendly, and helps keep your investment growing. If you just want a steady income SWP is usually the better choice and if you want compounding then GROWTH options in mutual funds are better .So before picking IDCW, think about your goals, how much tax you’ll pay, and whether you’re okay with unpredictable payouts.

And If you're unsure how IDCW works or need expert guidance on investing in mutual funds, we’ve got you covered! Book a FREE consultation call with our experts, get your doubts cleared, and make informed investment decisions with confidence.