Mutual Fund investment is taken as one of the efficient ways of investing because it offers a wide range of schemes with facilities that suit various kinds of investors. There are two ways either Growth MF or Dividend MF.
Mutual funds offer both dividend plans and growth plans through their schemes. The difference in the two is that the dividend plan offers interim payouts from the returns generated, whereas the growth plan in mutual funds, does not offer the facility of interim payout to its investors.
In the growth plan of mutual funds, gains that accumulate in the fund are reinvested automatically in the fund whereas in the dividend option profits are given out to investors on regular basis.
Let us know how these two plans of mutual funds, Growth, and Dividends are taxed.
The plan of mutual funds is generally the choice of those investors who are looking for a regular income from their investments. Before this financial year, the dividends received in the hands of investors was tax-free. These dividends schemes used to pay a dividend distribution tax (DDT) which was adjusted against the final payout made to investors. For equity mutual funds, this was at 11.64% and 29% for debt mutual funds.
After the announcement of the Union Budget 2020, now the dividends received by investors are taxable. For those in the highest tax bracket, they may have to pay tax, anywhere between 35% to 42% on the dividends income they receive from mutual fund schemes.
Growth plans in debt funds and equity funds are taxed separately based on the capital gains. For debt mutual fund schemes, short term capital gains in the growth option are taxed at income tax rate, long term capital gains (if you hold for at least 3 years) are taxed at 20% on indexed cost.
In the case of equity funds, gains from growth option are taxed at 15% for short term capital gains and 10% for long term capital gains on schemes held for at least one year.
Switch Or Not?
Well if you are a dividends plan investor and is unaware of the recent change in the taxation trend for dividend plans, you think that the growth plan is much better for you, you can consider switching to a growth plan of the same scheme. For that, you will have to fill an application to the switch from a dividends plan to the growth plan. When you change the plan from dividend to growth, the scheme remains the same, only the NAV changes, as the NAV of both plans is different.
If you are a long-term investor, while switching your plan from dividends to growth, you might end up paying capital gains tax on any accumulated gains at the time of the switch. It’s much better if instead of a switch you thought to sell your investment and buy a new one. If you have just started your investment or you are a recent investor you may not have to contend with high capital gains tax, but you must enquire about the exit load cost (if any) associated with your scheme on redemption.
As per financial and mutual fund experts, sticking to the growth option of mutual funds is much better be it debt or equity. This is because, it will be more tax-efficient in the long run, and no payouts mean your investment value can accumulate better over time.