Mutual funds: Unless regular income is needed, growth option is preferable

By: | Updated: March 15, 2018 3:00 PM

The Union Budget 2018 introduced a tax of 10% on both long term capital gains (LTCG) and dividend distributed by equity-oriented mutual funds. Debt funds already attracted dividend distribution tax of 28.84%, while LTCG attracted 20% tax, with indexation benefit.

mutual funds, MF distribution, ETF, gold, gold ETF, Gold Exchange Traded Funds, ETF period, budget 2018, union budget 2018, dividendsHence, unless a regular income is required, investing in growth option is preferable.

Q1. As I have to pay tax on dividends, should I switch to growth option? – Bibhu Lele

The Union Budget 2018 introduced a tax of 10% on both long term capital gains (LTCG) and dividend distributed by equity-oriented mutual funds. Debt funds already attracted dividend distribution tax of 28.84%, while LTCG attracted 20% tax, with indexation benefit. For taxation purpose, for equity and balanced funds, investment period of more than 12 months, and for all non-equity funds, investment period of more than 36 months is considered as long term. Thus, dividend and growth options attract tax. Apart from the taxation point of view, if one is investing in funds from a long-term wealth creation perspective then investing in growth option offers the power of compounding. In case of a dividend option, gains made on the principal amount are distributed to the investor. Thus, the amount that remains invested gets reduced by the amount of dividend paid, which results in the investment corpus growing at a below-potential rate.

Hence, unless a regular income is required, investing in growth option is preferable. If regular income is required, then a dividend option may not fulfill the requirement. In a dividend option, dividend is paid only if the scheme books profit. As such, the frequency and the amount of dividend paid is not fixed. Thus, if regular income is needed then one can go for systematic withdrawal plan (SWP). If one is eligible for LTCG tax, then SWP would be more tax efficient as well, as each withdrawal is treated as sale.

Q2. In gold ETF, is there lock-in period? — Adiyta Singh

Gold Exchange Traded Funds (ETF) invest directly in gold (purity of 99.5%) and the dematerialised units are listed on exchanges. These units can be sold on exchanges, that they are listed in, at any point in time during market hours. As such, there is no lock-in period. However, the NAV of ETF unit may differ from the price of equivalent amount of gold in the physical market, due to the management fees charged by the AMC. The expense ratio charged is typically around 1.0% per annum, of the daily net assets. Moreover, price of the units on the exchange may differ slightly from the NAV of the ETF, as it depends on the demand-supply dynamics on the exchange. Also, like physical gold, one would need to hold the ETF units for at least 36 months to be eligible for LTCG tax, which is 20% after indexation benefit.

The writer is director, Investment Advisory, Morningstar Investment Adviser (India).

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