Mutual funds, be it equity or debt funds, offers investors 2 choices; growth and dividend plan. You can choose the plan based on which suits your needs the best. Each plan has its own implication in periodicity of returns, relevance for financial planning and tax efficiency.
Let us look at the concepts
- Growth Plan: Growth plan of a mutual fund does not offer any payout. Profits made on the portfolio are necessarily invested back into the scheme and subsequently, you start generating return on returns made. This is how compounding of your wealth takes place.
- Dividend Payout Plan: In this plan, the fund declares dividends out of profits. A fund can pay dividends only out of profits and not out of capital. That is applicable to equity funds and to debt funds. The NAV of the dividend plan reduces to the extent of the dividends paid, which is why you will find the NAV of a dividend fund always lower than a growth plan.
In both cases, you will make the same return, however, in case of a dividend option you have the profits in your hand and in the growth option they get added back and reinvested.
Now let’s compare both the plans –
The primary and major difference is the tax efficiency of the two plans. In the dividend plan, dividend received is tax-free in the hands of the investor but will attract dividend distribution tax (DDT) @10%. Only after deducting the DDT, the dividend is distributed to the investor.
In growth plan, if money is withdrawn through SWP, capital gains tax is applicable (short term capital gains tax @15% if withdrawn within 1 year, and @10% if after 1 year)
Please note, dividend distribution tax (DDT) is applicable on the entire dividend amount, while capital gains tax is applicable only on the gains made and not the entire amount withdrawn.
Let’s compare both the plans through the below illustration –
In the below graph you can compare the tax outflow for SWP of Rs. 10,000 vs. dividend of Rs. 10,000/-. Clearly, tax liability in case of dividend plan is 2 to 3 times the tax liability in case of SWP.
And hence, opting for SWP in growth plans is much more tax-efficient than opting for dividend plan in mutual funds.