Dividend vs Growth plans is a long ongoing debate and we have pitched in with our views in the past. With recent changes in tax laws, the right choice for investors in equity funds has tilted in favour of growth schemes over dividend schemes. Let me tell you how:
Here are 3 things you need to know:
When you withdraw, the tax rate you have to pay varies from 0-15% depending on your situation. But, when you get a dividend, you have to necessarily pay 10% tax (Actually 11% if you consider the effect of grossing up)
When you withdraw from mutual funds, you pay tax only on the gains portion of your withdrawal. If you get a dividend, you pay tax on more than what you receive in hand.
Example: if you invested Rs 1 lakh and it became Rs 1.1 lakh. Then you withdraw Rs 10,000. In the withdrawn amount, the gain is only Rs 990 and you pay tax on that. When you get a dividend of Rs 10000, you pay tax on approx Rs 11,000. This is because dividend payout is grossed up for tax.
When you withdraw, you are in control and can decide how much to withdraw to make sure you pay less taxes. In case of dividends, the timing and amount is determined by the fund manager. Tax is deducted before being paid to you and there is no way to claim it back.
In many cases, people invest into dividend schemes, with the intent of receiving regular cash flows. But this cash may not be needed at that point in time. As a result, the investors land up paying taxes on this dividend, and then ploughs this dividend back into other investments. This leakage is a very common occurrence. Whereas, if the investor had allowed the money to grow in the same fund, via a growth scheme, there would not have been any incidence of tax.
Example: If an investor puts in Rs 10,000 into a growth fund. Let’s assume that this fund delivers 15% pa return. Over 25 years, this fund would be worth Rs 2.86 lakhs. On the other hand, if the investor had invested in a dividend scheme, and all gains for the year was paid out as dividend and put back into the same fund, it would be work only Rs 2.08 lakhs at the end of the period. So, unless your main objective is to keep paying taxes to the government, you are better off with the growth scheme
Example: When you withdraw, your tax could be zero in below cases
(i) The long-term capital gain could be within the Rs 1 lakh limit leading to zero tax.
(ii) All or part of your withdrawn investment may be in loss and no tax will be payable.
(iii) Your gain may get offset against other capital losses.
So don’t opt for dividend plans. Go for growth.
Note: Scripbox has always recommended only growth plans in both equity and debt funds.