The Ideal Plan

Which plan is ideal for me- growth, dividend payout or reinvestment?
- Anonymous

The treatment of gains and taxes are the two essential features that differentiate these plans. If evaluating the returns from an investment at a point of time, there is no difference among the three options. The difference emerges in an implicit form with respect to the applicable taxes.

Gains: In case of a growth plan, gains made are reflected in the higher NAV of the fund. The capital appreciates and investors can cash in on this by redeeming units. Under this option, the decision of booking profits is that of the investor. In case of dividend plans, the fund manager takes a call and distributes gains amongst investors in the form of dividends. Under the dividend payout option, the dividend is paid to you and the NAV falls by the extent of such a payout. It is up to you to reinvest that money as you deem fit. In case of dividend reinvestment, the dividend is paid out by issuing additional units. Hence the dilemma of reinvesting your dividends is taken care of. The biggest benefit here is that the discretion of booking profits is left to the fund manager.

Taxation of Equity Funds: As far as the growth option is concerned, one needs to pay taxes on capital gains. If the units are sold within a year, a short-term capital gains tax of 10 per cent is levied. There is no tax payable on long-term capital gains which comprise of units held for more than a year.

Dividends are tax free in the hands of the investor. When a fund house distributes dividends, it is required to pay a dividend distribution tax (DDT). There is no DDT applicable on dividends declared by equity and balanced funds.

So if you intend redeeming units within one year of investing in a fund, you would be better off under the dividend option. But such a strategy is not foolproof for investors will be at the mercy of the fund house to distribute dividends. Not to mention the fact that an investment time horizon of less than a year is not advisable for investing in equities.

Taxation of Debt Funds: The treatment of debt funds is slightly complicated. Dividends distributed are liable to DDT which implicitly eats into the corpus that could be potentially in your hands. In case of money market or liquid funds, the DDT (inclusive of surcharge and cess) amounts to as much as 28.33 per cent. For all other type of debt funds, the DDT (inclusive of surcharge and cess) amounts to 14.16 per cent for individuals and Hindu Undivided Families. The tax for all other assessees stands at 22.66 per cent.

In case of debt funds, a short-term capital gains tax depending on your income bracket is levied for units redeemed within a year of investment. Long-term capital gains tax is 10 per cent (plus surcharge) without indexation and 20 per cent with indexation. Therefore, purely in terms of tax efficiency, one ought to stick to the growth option in case of money market and liquid funds.

For all other debt funds, if you are in the middle or higher tax slab paying 20 per cent or more as income tax, then the dividend option will make more sense over the short term. For the long-term debt investor, growth would be the way to go.

Making the right choice: Some people prefer using the dividend payout option as a source of regular income. The glitch with this is that funds are not obligated to declare dividends even under a monthly dividend plan. Moreover, the quantum of the payout will not be consistent. Our advice is not to opt for the dividend option as a monthly source of income. You would be better off instituting a Systematic Withdrawal Plan for this.

The dividend option is suitable for those who would like to book profits regularly and redirect such money to other financial instruments such as a fixed deposit. For all other purposes, the growth option offers more flexibility in decision making.

There is an exception though. In case of ELSS or tax planning funds the dividend payout plan is superior. This is because the dividends paid out are not subject to a three-year lock in. And while you cannot redeem your principal units for three years, under the dividend payout option you can at least avail of the profits made here. However, one should absolutely steer clear of the dividend reinvestment plan under this category because the additional units received are subject to the three year lock in.