When it comes to investing in mutual funds, there are a lot of sites which would give you top 10 funds to invest in. But probably there is not much knowledge out there on different payout options available while investing into mutual funds. Take it this way, a wrong payout option chosen while investing into a mutual fund can either defeat your investment objective or land you into avoidable tax bills. This article aims to demistify different options which are available in the MF market and how to make the best out of them to further your investment goal. You may want to refer to our article What is a Mutual Fund which is a precurser to the decisions involved in selecting the right Payout Option.
What is a Payout Options
When investing into a mutual fund, a fund house gives an option to an investor to express his way of receiving the returns in the mutual fund. These are called Payout options. Broadly, there are three options :
Just like shares, mutual funds also declare dividends. These dividends are tax free in the hands of the investors and are sent to the investor via cheque (in case an investor opts for cheque payments) or credited directly into the bank account of the investor (in case an investor opts for the direct bank credit option).
Dividend Distribution Tax
Depending upon the type of mutual fund scheme, a mutual fund house may deduct an upfront DDT-Dividend Distribution Tax (just like TDS) before sending out the payment. For all Equity schemes, the DDT is currently zero. For Bond schemes, it is generally around 15%. For Liquid funds, DDT is around 27%. For details on DDT, you may refer to Tax Implications of Mutual Funds on Residents and NRIs.
When the dividend is declared, the NAV of the respective mutual fund gets reduced by the dividend amount. For example, if the NAV of a mutual fund scheme before declaration of dividend was Rs. 20 and the mutual fund declares Rs. 2 dividend, the NAV after the dividend is paid shall reduce to Rs. 18.
If an investor has opted for Growth option, the mutual fund house shall not provide such an investor with regular dividends which it declares. However, it does not mean that the investor is at loss. The NAV of mutual funds invested with growth option does not decrease by the dividend amount, and hence indirectly the returns of the investor is reflected in the form of higher NAVs.
For example HDFC Equity Fund has a NAV of Rs. 241 (as of 14 May 2012), while the same scheme invested with dividend option on the same date has a NAV of Rs. 37. You may notice that if you had 1000 units in HDFC Equity Fund, the value of your holdings with Dividend Option shall be Rs. 37,000. However, if the investment was made with Growth Option, the value would be Rs. 241,000. The differential amount has been paid back to the investor in the form of Dividend Payout.
From Tax perspective, the investors using growth option get primarily taxed via Capital Gain Tax which is the difference between the cost of investment and the market value of the investment on the date of sale. Depending upon the type of mutual fund, the capital gain can be :
|Duration||Equity Funds||Non Equity Funds|
|10% without Indexation
20% with Indexation
NRIs are taxed slightly differently. For details on taxation on Mutual funds, please refer to our article Tax Implications of Mutual Funds on Residents and NRIs.
This option is a hybrid between Growth Option and Dividend Option. Just like a Dividend Option, the mutual fund house declares a dividend on the scheme. The NAV of the scheme gets reduced by the extent of dividend. However, instead of paying out the dividend in cash, the mutual fund invests the dividend at the ex-dividend NAV in the same scheme.
Lets take a hypothetical example. HDFC Equity Fund has a NAV of Rs. 50, when it gives a dividend of Rs. 10 per unit. Mr. A has 1000 units of the scheme and he is hence entitled for Rs. 10,000 (1000 units X Rs. 10) dividend. However, since he opted to invest with ‘Dividend Reinvestment’ option, the mutual fund house instead of paying him cash, allotted him additional units for Rs. 10,000. So in the example, the ex-dividend price of HDFC Equity Fund falls down to Rs. 40. Mr. A is allotted fresh 250 units (Rs. 10,000 / Rs. 40), taking his total number of unit holdings to 1,250 units. If you would notice, the value of Mr. A’s holding is still Rs. 50,000 (1250 units X Rs. 40 per unit). Hence it didn’t really make a difference if he invested via Growth Option or Dividend Reinvestment from overall value of investment perspective. However, his number of units increased from 1,000 to 1,250.
When to Choose Which Option
We have now reached the most important part of this article which helps to take the decision of the right payout option for your funds. The answer likes in the tax impact of a fund on an individual and the requirement to have regular dividends. Hence, it can not be ‘one size fits all’ response. NRIs get taxed differently than Resident Individual and so does Corporate entities. Even within Resident Individuals, people get taxed differently based upon the amount of their taxable Income. Lets go through each of the options :
When to Choose Growth Option
As per the current tax laws, Long term capital gain tax is tax free for Equities and so is dividend Income. However, this was not always the case. After every 5-6 years, government takes away the ‘Tax-Free’ status of Dividends. Also, depends upon the requirement to incentivise the investment into Equity markets, the goverment may take away the tax rebates on long term capital gain tax on Equities.
Based upon the current tax laws, we can suggest the following :
- Invest into Equity oriented mutual funds with Growth Option as after 1 year the entire amount of gain would be tax free. However, if the tax situation changes, this strategy should be reviewed.
- For Non Equity Funds – Invest with Growth Option only if your total taxable income is less than 10% tax bracket. Long Term Capital Gain Tax on Debt funds get taxed at 10% – 20% rate. However, a resident individual is not required to pay any tax upto the minimum taxable slab (currently Rs. 200,000).
- For NRIs invest only via Growth Option. This would prevent getting additional dividend income being credited in your bank accounts which would attract taxes in your respective foreign country. NRIs may face TDS in case of non-Equity funds at the time of selling the units, however, this amount may be recovered by filing a tax return (only in case of Short Term Capital Gain Tax – Bond Funds).
When to Choose Dividend Option
If you need regular income, you may want to opt for ‘Dividend’ option. Dividend income is currently tax free and hence you can enjoy a tax free income. However, as referred to in the earlier paragraphs, mutual fund houses deduct Dividend Distribution Tax on Debt Funds. Hence from a Tax perspective, you may want to do the following :
- For Non Equity Funds – Invest via Dividend Option in Debt funds if your taxable income is above 20% tax slab. Mutual fund houses deduct around 15% DDT for debt funds (27% for Liquid Funds) and then distribute the income to the unit holder. So if you are in the 30% tax bracket, your returns from the mutual fund shall be distributed to you after deducting 15% tax. The remaining 85% of your returns would then be tax free. Hence for example, if your debt fund has Rs. 1000 return, it shall provide you this return after deducting Rs. 150 as DDT. Remaining Rs. 850 which shall be credited in your bank is tax free.
- For NRIs – do not choose Dividend Option as it would attract additional taxes in your foreign country. Further, DDT deducted on Dividend Option is not recoverable via filing of annual tax return, hence it makes no sense to go via Dividend Option for NRIs.
When to Choose Dividend Reinvestment Option
Dividend Reinvestment Option faces the same tax impact as of Dividend Option and hence follows the same suggestions. With every dividend payout getting invested, it increases the cost of acquisition of the units in the mutual fund. This reinvestment, though tax free for Equity Funds, attracts DDT for Non-Equity Funds which unnecessarily adds as a drag to your overall returns. At the time of final redemption, the market value of the units is very close to the cost of purchase of the units, resulting in no or very less amount of additional taxes to be paid.
Considering that this option does not provide any additional advantage, I tend to stay away with this option as it results in complicating the computation of cost of purchases of the overall units.
The topic of choosing the right option is not very straight forward and may require a bit of digging into each person’s tax status and the requirement to have a regular cash flow. I would strongly recommend to consult your financial advisor who is also proficient to deal in your specific tax scenario to arrive at an optimum Payout option. If you need any specific help, you can ask a question at the bottom of this article.
32 Replies to “Payout Options in Mutual Funds”
very informative article. it is wise to invest in mutual fund through growth option.
Very nice post..mystery resolved 🙂
Indeed go with Growth option, unless you need regular dividend Income. For Debt funds, the option depends upon the tax impact on the investor.
Excellent Article dear BFA,
Cosideration of Addition in Article : NRI who lives in tax free country. ( will be same as you described in article? )
As you would have noted, the options have to be closely matched with the tax impact of a NRI and their requirement to have regular income. Assuming that you don’t require regular income and are living in a tax free country, then you may want to go for growth option for all Equity & Balanced funds. For Liquid funds, it may be a good idea to go with Growth Option as well and claim a refund of TDS being deducted by the MF at the time of redemption.
Does that answer your question ?
A very well written understandable article but have a doubt regarding.
I invested in a debt mutual fund (non-liquid)- dividend option & redeemed it after 1 or 2 months.Do i have to pay STCG as per my tax slab OR is the proceeds tax free in my hands even though I redeemed it before 12 months?
Also what happens if the above sceneario is applied on a MF (Fund of Funds) dividend scheme
You have raised very good questions. My responses are :
1. Any dividend credited in your bank would be tax free;
2. Generally from the time dividend is paid to the time next dividend is paid, the NAV of the fund tends to accrue the dividend payable. If you sell any where between these two dates, you don’t get dividend, but a STCG (if within 1 year) which gets taxed as per your tax slab. Hence, the best option is to go for weekly dividend option in case you want to completely get away with STCG.
3. Fund of Fund – best option is to read through the Scheme Information Doc of each MF. Generally FoF of Indian funds would behave in line with the details I have mentioned in my article.
Useful article. Self has some investment in equity funds as sip and don’t monitor them frequently nor use those funds. Hence i chose dividened-reinvestment option. Is this advisable. I am a resident indian but maintaining NRI status working abroad.
Before I could answer, please could you clarify how are you classifying yourself as a resident individual and working as a NRI abroad ?
Yes i am a sea man. I am maintaining my NRI status of 183 days.
Dividend reinvestment option does not make sense to me. It doesn’t add any investment value. Further, dividend reinvestment option ends up attracting tax in foreign countries, even though it may be tax free in India. Hence, I would suggest you to invest in Growth option.
i am an NRI based out of USA.. i eventually wanted to come down and settle in india.
so i have been investing only on flats so far that are immediately rentable and making
decent rent out of these flats.i want to invest more..but only on flats..and not on any plots or land…as i dont have anyone really close/trustable to manage my properties in india, i feel that investing in flats are more safe and easily manageable with decent tenants than investing in plots/land that could easily get into wrong hands if not watched over/looked over.
but i wanted to take step back and think whether investing on flats is really a good decision on a long run..say 30 years after..
please advise on this..whether to go for immediately rentable flats or on vacant lands..
basically pros and cons do you see with investing in flats.
I would agree with you for investing into Flats owing to ownership risks in India. However, I must admit that houses / plots give higher long term growth compared to flats. Are you aware of Wealth Tax requirements in India where any residential property which is not rented (exemption of 1 property), is subject to 1% annual Wealth Tax.
You could also look out for diversifying your property base by going for :
1. Commercial Properties which fetch higher rental yields.
2. Buying smaller units of plots / houses;
3. Equity markets via Mutual Funds.
i am thinking on investing on some residential properties in chennai,
i am an NRI and do have little contacts there..
is it ok to go through a real estate agents for this.how reliable are they
and what is the standard commission that they would charge for this as a buyer for me and at what time do i need to make the commission payment to them.
i really dont want to deal with the end party directly and go trough negotiations and other
paper work that will consume my time..so, thinking is it really advisable to go through real
estate agents and what to expect from them.
The property markets in India are not as organised as you see in overseas. The agents won’t be safeguarding your interest as they get brokerage from both the buyer and seller. This is generally 1% of the value of the deal. Max what you can expect is getting a property, but all negotiations and diligence would need to be done by you.
If you are interested about looking into Delhi real estate, I might have a reliable consultant / advisor for the real estate transactions who will keep your interest upfront.
i want to invest on buying plots in outskirts of chennai………i see ads from many agencies..is it advisable to buy these plots from agents.
also, kindly clarify me on the following:
1. if the plot falls outside of cmda limit, what sort of approval should we check for..in case if i want to construct a house on it later in future
2. is it true that plots within cmda limit appreciate more
3. other than soil test, what other test should i check on the plot meant for residential purpose.
apart from these, what other things do we need to check while buying plot of land.
is it always advisable to buy these land./plot through bank loan especially from nationalized banks so that rest assured bank will do all the check thoroughly.
Every thing comes with a cost. Plots closer to the city centre would be expensive. However in my opinion the plots outside the city tend to grow faster than the one in city centre.
1. I am not a legal expert for land transactions. Would recommend you to hire a local lawyer to help these checks done. On a min you need to check if the land is residential and not agricultural, right of the seller to sell the land.
2. Answered above.
3. Answered in 1.
Banks wont provide you residential home loan on plots unless you are building a house on it.
why is the inr against usd rock side high in the last few weeks..
is rbi taking steps to control this?
how long is this expected to last?
is it expected to increase even more?
what major factors are causing this to happen.
i have a foreign investment deal to initiate but the above things are making me to re-think
on my decision and see if i had to wait for some time and watch the market.
i am an NRI
looking to invest on some residential land in the outskirts of chennai.
i often come across this term called plot.
what exactly is the difference between residential land and plot.
are they one and the same.
Yes. In colloquial sense, the builders and agents will use them interchangeably.
i am looking to invest in some land in south india- am an NRI –
it is my understanding that at the least i should check the following –
but have few questions –
1. patta = will it be on developer name ? should i get it changed to my name
2. sale deed – will the builder have it especially if he has big layout tht is being divided and sold
3. dtcp approval – if in the outskirts of the city
4. parent document – what exactly is it
5. ec for 33 years – 30 for computer and 3 yr manual.
i understand there could be more..but just to check the basic genuinity check..is the above sufficient.
does any of the above tell whether it s a agricultural/non agri land..
are dtcp approval full valid like cmda approvals..?
i heard there is something also called panchayat approval.what are they..
finally..does the above documents help me legally evict someone in case if there is any encroachment on the land in future.
i bought a flat few years back when i was abroad in US..this is the heart of the city in bangalore ..at that time, i gave the power of attorney to my mother…and the flat was on my name,….
i recently paid off and closed the loan.loan was taken from a nationalized bank…
but when i tried to cancel the power of attorney..i am being told by few of the agents
that it impossible to cancel the power of attorney given from abroad..or atleast hard to do that…..is that true.
can a power of attorney given from abroad be cancelled. please advise
I would strongly suggest you to hire a local advocate who specialises in real estate regulations to do all the background checks for you. I must admit that I am not a specialist in real estate regulations.
POA can be cancelled at any time irrespective of where you are. To cover yourself, send it via registered post to all the relevant parties who would have got a copy of the POA. In future, when you give a POA, make sure that you have an automatic expiry clause in it such as End date of the POA, limiting it to the specific transaction only.
i want to purchase a land in chennai that has only panchayat approval..is it possible to get
bank loans with these kind of approval.
even if i get the bank loan approval..is it advisable to buy lands with just thse approvals..is it possible to apply for dtcp/cmda approval using this in future
basically,how credible are these approvals from panchayat
i recently took a home loan with SBI – NRI home loan..i was asked to do a equitable mortgage
for which i had to shell out additional 30k..for this..
i heard other banks like private banks doesnt do this equitable mortgage.
why is this specific to SBI..what makes them additionally safe by doing this when they actually have all my originals..is it true that…with the equitable mortgage..banks doesnt have to go through any court proceedings and can just take over my land if i default at any time.
i wanted to invest on a 2bhk flat..but the builder is giving me only 20% flat UDS..
which is actually low to me.
but is it true that if the UDS is higher, then the resale will be higher.?
is there a way for me to negotiate for higher UDS..or are these government set standards
The best way to get this clarified is to consult a property lawyer. Avoid real estate agents, though they would provide you some insight around the process.
There is set standard for UDS. The poorer UDS you get, the less reliable is your real estate developer. To get an understanding of it, compute your UDS by :
Your sq feet flat area
—————————————– x Total area on which the flat is build
Total sq feet of all flats in the building
If your calculations are not tying in with the builder, question him to understand it. Definitely higher the UDS, the better price you get in future. The rationale being, as the price of the land increases, the value of the building depreciates. It is your UDS that commands the value of your flat and not the flat building.
what causes a mutual fund to make non-dividend distributions
What would you mean by non dividend distributions ?