IDCW vs Growth Option in Mutual Funds - Difference, Taxation, Example and Which to Choose

A mutual fund can generate the same portfolio returns, yet the investor’s experience can look quite different depending on the option chosen. Under Growth, gains remain within the scheme and continue to be reflected in the NAV. Under IDCW, the scheme may distribute part of its distributable surplus, creating a cash flow while reducing the NAV by the amount distributed, subject to applicable adjustments. The difference is therefore not about two different investment strategies, but about what happens to the money after it is generated.

Key Takeaways

• Growth keeps returns invested until redemption
• IDCW may distribute part of the distributable surplus
• IDCW is not guaranteed and is not an additional return
• IDCW Payout provides cash while IDCW Reinvestment provides additional units
• Growth and IDCW have different tax implications
• SWP offers greater control over planned withdrawals
• The choice should depend on the investment objective and cash flow requirement

IDCW vs Growth - The Short Answer

The real difference between Growth and IDCW is what happens after the fund earns money. In Growth, the gains stay within the investment, so the money continues working through the same portfolio. In IDCW, a part of the distributable surplus may move out to the investor and the NAV adjusts downward by the amount distributed, all else being equal. That makes the choice less about earning versus not earning and more about staying invested versus taking money out. 

What is the Growth Option in Mutual Funds?

Under the Growth option, the income and capital gains generated by a mutual fund scheme are retained within the scheme rather than distributed to investors. These gains remain part of the scheme's assets and are reflected in the Net Asset Value (NAV) of the units. Consequently, the value of an investor's holdings changes in line with the scheme's NAV, subject to market movements, expenses and other factors affecting portfolio value. The Growth option does not involve periodic distributions merely because the scheme has generated income or realised gains. Instead, investors generally realise the accumulated value through redemption of their units. This structure allows returns to remain invested within the scheme and may support the compounding of returns over the investment period.

What is the IDCW Option in Mutual Funds?

IDCW stands for Income Distribution cum Capital Withdrawal. Under the IDCW option, a mutual fund scheme may distribute a portion of its distributable surplus to investors, subject to the availability of distributable surplus and the scheme's terms. An IDCW distribution is not an additional return over and above the scheme's performance. When a distribution is made, the scheme's NAV is reduced to the extent of the distribution, along with applicable statutory levies, if any. The amount and frequency of IDCW distributions are not predetermined or guaranteed.

Why SEBI renamed 'dividend' to IDCW in 2021?

In 2021, SEBI replaced the term Dividend with Income Distribution cum Capital Withdrawal (IDCW) for mutual fund schemes. The new terminology came into effect from April 1, 2021. The change was made to help investors better understand what a mutual fund distribution means. Unlike a company's dividend, a mutual fund distribution is not necessarily a payment from the scheme's profits. It may include income or realised gains, depending on the scheme and the amount available for distribution.

When an IDCW is paid, the scheme's NAV reduces by the amount distributed, subject to applicable adjustments. This means the distribution is not an additional return over and above the value of the investment.

IDCW vs Growth - 11 Key Differences 

Growth and IDCW are two options within a mutual fund scheme that can have the same underlying portfolio and investment mandate. The important difference lies in how the scheme treats distributable income and realised gains, how investors receive money from the investment and when taxation may arise.

IDCW Payout vs IDCW Reinvestment:

The difference between the two IDCW sub-options comes down to what happens to the distribution when it is declared. With IDCW Payout, the declared distribution is paid to the investor. This provides a cash flow outside the scheme, while the NAV adjusts downward by the amount distributed, subject to applicable adjustments. With IDCW Reinvestment, the declared distribution is used to allot additional units to the investor instead of being paid out as cash. The investor therefore holds more units after the reinvestment, while the NAV adjusts for the distribution.

How an IDCW Payout Actually Works?

An IDCW payout begins when a mutual fund scheme declares a distribution under its IDCW option. The amount is paid to eligible investors according to the applicable record date and scheme provisions. The process can be viewed in a few simple steps.

1. The scheme declares an IDCW: The fund house announces the distribution amount per unit and the relevant dates
2. Eligible investors are identified: Investors holding units on the applicable record date become eligible for the declared distribution, subject to the scheme's provisions
3. The distribution is paid: Under the IDCW Payout option, the declared amount is paid to the investor through the registered payment mechanism
4. The NAV is adjusted: After the distribution, the NAV of the IDCW option falls by the distribution amount, subject to applicable adjustments

For example, if an investor holds 1,000 units and an IDCW of 2 per unit is declared, the investor is entitled to a distribution of 2,000, subject to applicable taxes and other statutory adjustments. The payment does not represent an additional gain created by the distribution. It is a distribution from the scheme's available distributable surplus.

Growth vs IDCW Over 15 Years - The Compounding Gap

Consider an illustration where an investor starts with 10 lakh, the investment generates an assumed 12% annual return and the IDCW option distributes approximately 6% of the portfolio value at the end of each year. This is only an illustration. Actual mutual fund returns, distributions, taxes and NAV movements will differ.

Growth:

IDCW:

So, approximately:

• Final IDCW portfolio value - 16.73 lakh
• Cumulative IDCW - 7.73 lakh
• Total value received - 24.45 lakh

IDCW vs Growth Taxation

The taxation of Growth and IDCW options differs mainly in when the investor becomes liable to tax. Under the Growth option, tax generally arises when the investor redeems units and realises a capital gain. The tax treatment depends on the type of mutual fund, the holding period and the applicable tax rules. Under the IDCW option, the amount distributed as IDCW is generally taxable in the hands of the investor in the year it is received. In addition, any capital gain arising when the units are eventually redeemed is taxed separately under the applicable rules. Therefore, the choice between Growth and IDCW can affect the timing and nature of the investor's tax liability. Investors should consider their cash flow needs, holding period and applicable tax treatment rather than viewing IDCW as a separate source of return.

Is an IDCW Payout Guaranteed?

An IDCW payout is not guaranteed. The declaration, amount and frequency of IDCW depend on factors such as the scheme’s distributable surplus and the applicable declaration process. There is no assurance of a particular payout or a fixed frequency. Therefore, IDCW should not be treated as a fixed or assured income stream. This also differs from an SWP, where the investor can set a withdrawal amount and frequency, subject to the available balance and scheme terms.

Which is Better, IDCW or Growth? Who Should Choose Which

There is no single right choice between Growth and IDCW. The decision largely depends on what the investor wants the investment to do. Growth may be suitable for investors who do not need periodic cash flows and want their gains to remain invested. Over a longer investment horizon, keeping returns invested can support the power of compounding, as subsequent returns can build on the accumulated investment. IDCW may be considered by investors who prefer to receive distributions when declared, although the amount and frequency are not assured. For investors who need regular cash flows with greater control over the amount and timing, an SWP from the Growth option may also be considered, subject to the scheme’s terms and available balance. Ultimately, the choice should reflect the investor’s investment objective, cash flow needs and time horizon.

Choose Growth if -

The Growth option may suit investors who want to keep returns invested and do not require periodic cash flows. It may be appropriate when the investor

• Has a long investment horizon.
• Is investing towards a long term financial goal.
• Wants gains to remain invested in the scheme.
• Does not need periodic distributions.
• Prefers to decide when to withdraw from the investment.
• Wants capital gains taxation to arise when units are redeemed, subject to applicable tax rules.

With Growth, the investor can keep the investment intact and decide when and how much to withdraw based on their financial needs.

Choose IDCW if -

The IDCW option may be considered by investors who prefer to receive distributions when declared. It may be relevant when the investor

• Has a requirement for cash flows from the investment.
• Understands that IDCW is not assured and that its amount and frequency may vary.
• Is comfortable with the applicable tax treatment of IDCW.
• Prefers receiving distributions rather than initiating redemptions for every cash requirement.

Need regular income? Compare IDCW with SWP first

Investors seeking regular cash flows may want to compare IDCW with a Systematic Withdrawal Plan (SWP) before choosing an option. With IDCW, the amount and frequency of distributions are determined by the scheme and are not assured. An SWP, on the other hand, allows the investor to set a withdrawal amount and frequency, subject to the scheme’s terms and available balance. The two also differ in their tax treatment. IDCW is generally taxable as income in the year it is received, while an SWP involves redemption of units, with tax applying to the capital gain component under the applicable rules. The choice therefore depends on whether the investor prefers distributions declared by the scheme or a more defined withdrawal arrangement.

Can You Switch from IDCW to Growth?

An investor can generally move from the IDCW option to the Growth option. Such a switch is treated as a redemption from the existing option and a fresh investment into the other option. Therefore, any applicable capital gains tax and exit load should be considered before making the switch. The decision may be relevant when an investor no longer needs distributions and prefers to keep future gains invested within the scheme. The investor should also consider the existing holding period and tax implications before switching.

Common Mistakes Investors Make with IDCW

IDCW can be useful for certain cash flow needs, but it is often misunderstood. Some common mistakes include:

• Treating IDCW as guaranteed income: IDCW is not assured, and its amount and frequency can vary
• Assuming IDCW is an additional return: A distribution is paid out of the scheme’s distributable surplus and is reflected in the NAV. It should not be viewed as a return over and above the investment’s value
• Overlooking taxation: IDCW has its own tax treatment, which should be considered alongside the investor’s overall tax position
• Focusing on the payout rather than the investment objective: The presence or size of an IDCW should not be the sole basis for selecting a mutual fund. The scheme’s investment objective, portfolio and suitability for the investor’s needs remain relevant
• Ignoring the impact on the invested amount: Once a distribution is made, the amount distributed is no longer part of the portfolio. This matters when assessing the investment’s value over a longer period

Conclusion

Growth and IDCW differ in how returns are retained or distributed. Growth keeps gains invested until the investor redeems units, while IDCW may distribute part of the distributable surplus when declared. The distribution is not an additional return because the NAV adjusts accordingly. For long term wealth creation, investors may prefer to keep returns invested. Those seeking cash flows may consider IDCW, while an SWP can provide greater control over the amount and timing of withdrawals. The choice should reflect the investor’s objective, cash flow requirement and tax position.

FAQs

1) What is the difference between IDCW and Growth in mutual funds?

Under the Growth option, income and gains remain invested in the scheme and are reflected in the NAV. Under the IDCW option, the scheme may distribute part of its distributable surplus when declared. The NAV is adjusted after an IDCW distribution.

2) What is the full form of IDCW?

IDCW stands for Income Distribution cum Capital Withdrawal. The term replaced the earlier use of dividend for mutual fund scheme distributions.

3) Which is better, IDCW or Growth?

There is no universally suitable option. Growth may be considered when the investor wants returns to remain invested, while IDCW may be considered when the investor prefers distributions when declared. The choice depends on the investment objective, cash flow needs and applicable tax considerations.

4) Is an IDCW payout guaranteed?

An IDCW is not assured. Its declaration, amount and frequency depend on the scheme’s distributable surplus and applicable provisions. Investors should not treat IDCW as a fixed or guaranteed source of income.

5) Does the NAV fall after an IDCW payout?

When an IDCW is distributed, the NAV of the IDCW option is reduced by the distribution amount, subject to applicable adjustments. Therefore, the distribution should not be viewed as an additional return.

6) How are IDCW and Growth taxed?

The tax treatment depends on the nature of the transaction and the applicable tax rules. IDCW distributions are generally taxable in the investor’s hands in the year of receipt. Under Growth, capital gains generally arise when units are redeemed or transferred. The applicable treatment can vary based on the type of mutual fund, holding period and prevailing tax provisions.

7) What is the difference between IDCW Payout and IDCW Reinvestment?

With IDCW Payout, the declared distribution is paid to the investor. With IDCW Reinvestment, the declared amount is used to allot additional units to the investor, subject to applicable provisions. In both cases, the NAV is adjusted for the distribution.

8) Can I change IDCW to Growth? Is there any tax on switching?

An investor can generally switch from IDCW to Growth, subject to the scheme’s terms and availability of the option. A switch is treated as a redemption from the existing option and a fresh investment into the other option. Consequently, applicable capital gains tax and exit load, if any, should be considered.

9) Which is better for regular income, SWP or IDCW?

The two work differently. IDCW depends on distributions declared by the scheme and does not provide a predetermined cash flow. An SWP allows an investor to specify the amount and frequency of withdrawals, subject to scheme terms and the available balance. Their tax treatment also differs, so the appropriate choice depends on the investor’s requirements and tax position.

Disclaimers

Investors may consult their Financial Advisors and/or Tax advisors before making any investment decision.

These materials are not intended for distribution to or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation.  The distribution of this document in certain jurisdictions may be restricted or totally prohibited and accordingly, persons who come into possession of this document are required to inform themselves about, and to observe, any such restrictions.

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