When you invest in mutual funds, you have different choices, each with its pros and cons. Understanding these options is important before deciding where to invest. Let’s look at the Growth vs. IDCW Reinvest options to see which one might be better for your investment growth over time.
Growth option
In the Growth option, profits made from the investments are put back into the mutual fund, so your investment grows over time. However, you won’t receive any regular income from it.
In the Growth option of mutual funds, profits are reinvested into the same fund instead of being paid out to investors. This reinvestment causes the fund’s value or Net Asset Value (NAV) to increase over time. As a result, you can see your returns grow as the NAV increases.
This method gradually builds wealth by reinvesting profits, resulting in increased gains.
Payout of income distribution-cum-capital withdrawal (IDCW) option
Investing in mutual funds with an Income Distribution cum Capital Withdrawal (IDCW) option means you can get regular income from your investment. This income comes from the profits made by the fund. You can see your returns through both the money you receive and the increase in the fund’s value. However, these payments are not guaranteed. They depend on how much profit the fund makes and if there is enough money to distribute.
The income from an IDCW option is not regular or predictable. So, if you need steady and reliable cash flows, IDCW might not be the best choice. Instead, a Systematic Withdrawal Plan (SWP) might be better because it provides more structured and consistent payouts.
With a Systematic Withdrawal Plan (SWP), you can arrange to withdraw money from your investment at regular intervals. This gives you a steady income stream. Unlike IDCW, where payouts depend on the fund’s performance, an SWP lets you plan and know exactly when and how much money you will get, making it easier to manage your finances.
Reinvestment of income distribution-cum-capital withdrawal (IDCW (Reinvestment)) option
Reinvestment of Income Distribution cum Capital Withdrawal (IDCW (Reinvestment)) means any income you get from the mutual fund is automatically used to buy more units of the same fund. This is done at the current value of the fund. So, you can see your returns by looking at how much the value of the fund has increased compared to what you paid for your units, whether you bought them initially or through reinvestment.
The growth and IDCW (Reinvestment) options might look the same because both reinvest the profits back into the fund. IDCW (Reinvestment) keeps track of the reinvested income separately, showing it as new units. In contrast, the growth option just shows the overall increase in the fund’s value without breaking down the reinvested income.
Both options lead to investment growth. However, IDCW (Reinvestment) displays reinvested income as additional units, providing clarity on the source of returns. However, these options are different in their impact on taxes.
Categorizing taxation: Income distribution vs. capital gains
When opting for the growth option, any profits and increases in the fund’s value result in a higher Net Asset Value (NAV). These are known as Capital Gains, which are taxed at certain rates when you sell your mutual fund units.
With the IDCW (Reinvestment) option, the received income can be taxed as both regular income and capital gains. The capital gains are taxed similarly to the growth option. However, income from IDCW is taxed at your regular income tax rates, which can be higher than the lower capital gains taxes for the Growth option.
In the IDCW (Reinvestment) option, the holding period for your units starts from when you bought them. So, the original units you bought will have a longer holding period, while the units you got from reinvesting dividends will have a shorter one. If you don’t hold these units long enough to qualify for Long-Term Capital Gains (LTCG) (12 months for equity funds, 36 months for others), any gains might be considered Short-Term Capital Gains (STCG). Currently, STCG tax rates are higher than LTCG rates. For equity funds, STCG is taxed at 15% (plus extra fees), while LTCG is taxed at 10% (plus extra fees) after a yearly exemption of Rs. 1 lakh. For non-equity funds, STCG is taxed at your regular income tax rate, and LTCG is taxed at 20% (plus extra fees) with indexation benefits.
Both options help grow your investment. However, they possess different tax implications that may impact your overall returns.
Timing of taxation
Investors pay taxes for growth options only upon selling their mutual fund units at a profit.
With the IDCW (Reinvestment) option, the money you reinvest into the fund is taxed according to your tax rate. Even if you don’t get any cash from this reinvestment, you still need to pay taxes on it.
TDS incidence
Indian residents selling units and making a profit in the Growth option don’t have taxes deducted immediately.
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However, if you receive income distributions through the IDCW (Reinvestment) option exceeding Rs. 5,000 in a year, a 10% tax deduction applies. This tax is not put back into the scheme. So, this results in a loss of some compounding benefits, potentially affecting long-term growth
Just remember, the tax information provided here is based on the Union Budget 2022. Actual tax rates for capital gains depend on prevailing tax laws at the time of selling investments.
Final words
When choosing between Growth vs. IDCW Reinvest options for mutual fund investments, think about how much you want your money to grow, if you need regular income, and how taxes will affect you. Moreover, consider your goals, your risk tolerance, and how taxes will impact your returns before picking the right option for you.
