Dividend option in MFs are no more attractive

Several fund houses, as well as mutual fund distributors and independent financial advisers, were aggressively selling the mutual funds with dividend option to investors who are looking for regular income option, especially in equity-oriented funds. Dividends used to be tax-free in the hands of investors. So, they were considered as a tax-efficient product to generate steady income. This caught the eyes of investors towards dividend option in a mutual fund and corpus of balanced funds rallied for a short period of time. The government introduced a 10 per cent tax on dividends for all the equity mutual funds. This led many investors to move out of dividend giving mutual fund schemes.

Even without the tax consideration, the dividend option is not a good option to go with. This is because dividends are given out of the profits accumulated by the fund over the years. Giving out dividends is at the sole discretion of the mutual fund house. If the fund is going through a downfall the fund houses may opt not to pay the dividends. As the dividends are paid out of profits, NAV of the fund reduces to some extent and due to this over the long run, compounding effect also gets delayed.

There is a better alternative to the dividend option, that is SWP (Systematic Withdrawal Plan). SWP allows investors to withdraw a certain sum of money at regular intervals as defined by the investor from their investments. This way the investors are assured to get the income at regular intervals unlike the dividend option, which was at the discretion of the fund house. SWP would also not affect the NAV directly as affected by the dividend option, as in SWP investors withdraw from their investments and not the profits of the fund.

Small investors won’t be affected by the LTCG (Long Term Capital Gains) tax on equity mutual funds post one year, as far as the gain is less than Rs. 1 lakh, which is the threshold for exemption. Any realization of gains above Rs. 1 lakh would be levied 10 per cent tax. However, if withdrawals are made monthly then STCG (Short Term Capital Gains) tax of 15 per cent would be applicable.