Finance minister Arun Jaitley while unveiling the budget proposal for 2018-2019, came up with 10 percent Dividend Distribution Tax (DDT) on distributed income from equity oriented mutual funds. Additionally, as per the proposal, investors will have to pay 10 percent tax on long term capital gains (LTCG) from stock markets, exceeding Rs. 1 Lakh. This could possibly impact investor outlook as mutual funds have recently become quite a preferred investment alternative and have been gaining a lot of traction among investors. However, the step taken to introduce DDT could be viewed as a measure of parity in order to maintain balance and a level playing field between growth and dividend payout plans of mutual fund schemes. This also brings us to an important question to ponder upon - Which plan to choose from the point of view of tax efficiency?
Growth plan involves reinvestment of all the profits of the fund back into the fund, leading to compounding of wealth. Dividend plan however pays out dividend from the profits earned by the fund. Essentially, according to the experts, wealth effect remains the same in both the plans. Although the capital gains for both the plans would differ, it is imperative to understand that the amount paid out in case of the dividend payout plan evens out the difference in capital gains. This is how the wealth effect remains intact. Therefore, tax implication is a significant aspect to look at.
The dividend paid out in the dividend payout plan is tax free. However, 10 percent DDT will now be deducted by the fund house from the dividends distributed. Growth plans fall under the category of STCG if held for less than a year and are taxed at the rate of 15 percent. In case the investment period exceeds 1 year, it is classified as LTCG and taxed at the rate of 10 percent. Finance advisors suggest opting for growth plans as they will be more tax efficient compared to dividend plans. This would specifically be suitable for small and medium sized investors registering a profit of not more than 1 Lakh in a year from their equity mutual fund. The dividend payout plan is entirely managed by the fund house and it might even be left out in a particular month on account of lack of distributable surplus. Investors might as well consider switching their old holdings from dividend to growth option; which could be chargeable. Some fund houses may charge an exit load for the switch and some may not. In addition to the exit load or switching charges, paying LTCG tax of 15 percent becomes mandatory if the holding period is less than a year. It makes sense to opt for a switch which allows for more control and planning of taxes. Investors are hence advised to take a look at all the above factors before making a decision to move from dividend to growth option.
Another benefit offered by growth plans is that it aligns better with long duration investments due to the automatic compounding of wealth. This is a life saver and a source of credible wealth creation when it comes to long term financial planning.
However if the goal is to achieve a constant income flow, dividend payout plans would probably perform better since the payout could be controlled in the form of a suitable SWP. Investors could choose an appropriate SWP or Systematic Withdrawal Plan to facilitate regular flow of cash. This could particularly be apt for investors on the verge of retirement and those who are on the lookout for a steady stream of income.
The choice becomes clearer when investors are aware of their requirements and know what they want. Investors could select growth option for wealth creation with tax benefits or dividend option for a steady cash flow. The choice depends totally on individual financial goals. Investment horizon and taxation make growth option appear better than dividend option. The essential crux here is to go for growth plans if long term financial goals and tax efficiency are to be accomplished. Nevertheless, the most important consideration for an investor has to be the financial goal. Financial goals remain the starting point of every investment choice made and thus play a key role so it is best not to disregard it.