Dividends are nothing but your own money being returned to you. The fund’s NAV will fall immediately after announcing dividend, by an amount equal to dividend per unit.
Dividend option in equity plan is a losing proposition as compared to growth plan. Here’s why:
Dividend Plan: If a fund pays you Rs. 100 as dividend after Rs. 1000 becomes Rs. 1100, the net dividend to you after tax would be Rs. 90 and tax of Rs. 10
This is applicable for everyone not just for those who have more than Rs. 10 Lac in dividends.
Growth Plan: However, imagine you have growth plan, if you redeem Rs. 100 when fund NAV grows from Rs. 1000 to Rs. 1100, and you sell Rs. 100, your principal of Rs. 90.9 gets redeemed and capital gain of 10% on that i.e. Rs. 9.1. Tax will be charged on capital gain 10% of that is Rs. 0.9 versus dividend tax of Rs. 10 in above example.
But isn’t dividend plan better than growth plan in Debt funds?
Short term: Dividends in Debt funds pay dividend distribution tax (DDT) of 25%. Along with surcharge, the total DDT reaches roughly 28.33%. This is almost equal to marginal income tax rate of 30% in short term. In case of capital gains, short term capital gains on debt funds is paid at individual tax rate. Hence if you are a 30% slab investor, you will liable for similar tax rate on growth and dividend plans. However if you are a 10% or 20% slab investor, you will incur lower tax rate on growth plan.
Long term: Even in long term i.e. more than 3 years, long term capital gains tax on debt funds, you pay 20% after indexation, regardless of your income tax slab. This is substantially lower than dividend distribution tax at 29%. Hence, growth plan must be preferred.
What if I want regular income from my investments?
Since many investors rely on monthly/yearly dividends for personal consumption, it is wiser to opt for Growth Plan and sign up Monthly Systematic Withdrawal Plan rather than Dividend Plan. This works in reverse fashion of Systematic Investment Plan (SIP). Every month you will receive fixed number of value.
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