How to decide to choose Growth or Dividend mutual fund

Growth or Dividend mutual fund

Which is best growth or dividend plan for mutual fund
In a mutual fund scheme there are many choices for an investor. These all options are having their own advantages and disadvantages. So you have to choose according to your Investment goals. Among the more confusing decisions is the choice between a fund with a growth option and a fund with a dividend reinvestment option. Each type of fund has its advantages and disadvantages, and deciding which is a better fit will depend on your Investment goals.

Growth Option:
This high-risk, high-reward mantra is perfect for those who do not retire soon. Mutual funds come with growth plan and dividend plan. Under the growth plan whatever interests, bonus, gains and dividends the fund earns is reinvested in the same scheme, not distributed amongst the investors. This gets reflected in the NAV of the scheme, no interim payments whatsoever are made out of the fund holdings. The investor gets the return only upon redeeming the fund. So, the NAV of the growth plan and dividend option of the same scheme varies a lot. The NAV of the growth plan is much higher than the dividend plan as no pay-outs are made. If one is opting for an equity based mutual fund then the growth mutual fund is quite suitable as regards wealth creation. Hence no payouts are made, the power of compounding do a magic with your long term earning. And also long term capital gains from equity investment is non-taxable. But in case the fund is redeemed within one year then the tax rate is applicable as per investor’s current tax slab.

I the case of dividend plan dividends are distributed among the investors as per performance of the fund. Dividend option works best when markets are at all-time high. Moreover, if you are dependent on your investments for a regular income, the dividend option might work for you. However, you may lose on the compounding of returns aspect as dividends won’t be reinvested in the scheme. It results in slow growth in NAV of the fund. In dividend plan, there are two sub plans: Dividend Pay-out and Dividend Re-investment. In dividend pay-out the investor receives dividends in form of cash pay-out but in the latter option no cash is paid instead the dividends are re-invested and additional units are bought and credited to investor account.

how dividends are distributed

  • Dividend payout:

In this option dividend is directly credited to investor’s bank account. Such plans are suitable for the investors who want a regular cash flow but the NAV of the scheme grows slowly than growth plan.

  • Dividend re- Investment:

in this method the dividend is reinvested in same scheme. It is same as growth plan of mutual fund and helps in wealth creation over a period of time with the help of compounding.

Tax on dividend from mutual funds
The Finance Act, 2020 changed the method of tax on dividend. According to new Finance Act all dividend received on or after 1 April 2020 is taxable in the hands of the investor. The Finance Act, 2020 also imposes a TDS on dividend distribution by mutual funds on or after 1 April 2020, at the standard rate of TDS is 10% on dividend income paid in excess of Rs 5,000 from a company or AMC. However, as a COVID-19 relief measure, the government reduced the TDS rate to 7.5% for distribution from 14 May 2020 until 31 March 2021.

For example, Mr. Vishnu got ₹. 7,000 as dividend from a company on 15 June 2020. Since his dividend income exceeds ₹. 5,000, the company will deduct a TDS @7.5% on the dividend income which is ₹. 525. Mr. Vishnu will receive the balance amount of ₹. 6,475. Further, the dividend income is the taxable income of Mr. Vishnu taxed at the slab rates applicable for FY 2020-21 (AY 2021-22).

The Finance Act, 2020 also provides for deduction of interest expense incurred against the dividend. The deduction should not exceed 20% of the dividend income received. However, you are not entitled to claim a deduction for any other expenditure incurred for earning the dividend income. In the above example, if Mr. Vishnu borrowed money to invest in units of a mutual fund and paid interest of ₹. 3,000 during FY 2020-21, only ₹. 1,400 is allowable as an interest deduction.

TDS can be avoided
Submission of Form 15G/15H: A resident individual receiving dividends whose estimated annual income is below the exemption limit can submit form 15G to the company or AMC paying the dividend. Similarly, a senior citizen whose estimated annual tax payable is nil can submit Form 15H to the company paying the dividend. The AMC informs investor about the dividend declaration on their registered mail ID and requires submission of form 15G or form 15H to claim dividend income without TDS.

Investors can opt for growth or dividend option based on their investment goals. So, people who wish to grow wealth over the long term, usually opt for growth option – this is because the compounding benefit is lost when AMC pays you dividends.

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