What is better? MF dividend reinvestment or growth option
Depending on the tax bracket the mutual fund investor should decide on the investment option.
Investors are often on the lookout to save some element of tax so they think about the choice of a dividend or the growth option in mutual funds especially debt oriented funds. There is a lot of time and effort that is spent in this regard but in many cases this might not be warranted as there might not be much of a difference. It is vital to take a close look at the entire situation and then make a decision because it should not be that there are steps which actually lead to little savings or that there is actually a negative impact due to the move. Here is a detailed look at the entire issue and how this can be handled.
Changes
There has been a change in the conditions for debt oriented mutual funds wherein the time period of holding for the fund to be considered as a long term capital asset has been increased from 12 months to 36 months. The end result has been that any sale of units before this time period will result in a short term capital gains arising to the investor and this will be taxed at the rate that will be applicable to the investor. If the investor falls into the highest tax bracket then the tax rate could go upto 30 per cent. One of the alternatives suggested to investors in such a situation is to move towards the dividend reinvestment option but this might not yield to meaningfully better results. One needs to look at the overall situation and how this works out before a final decision can be made in the matter.
Highest rate
If an investor falls into the top tax bracket which would mean that they would be paying short term capital gains at 30 per cent then there would be some minor savings that would ensure when the shift is made to the dividend reinvestment option. The first thing to understand is that while the dividend is tax free in the hands of the investor there is an indirect cost that they are paying because there is a dividend distribution tax that is present at the time of the declaration of the dividend. So even if you are not receiving a payout from the fund there is the dividend distribution tax that has to be paid and this adds to the cost element for the investor. The other thing is that the impact on the investor of this tax is going to be 28.33 per cent. So this is a high figure and if the investor is in the top tax bracket then there is a marginal amount of savings that is taking place.
Other tax brackets
This also highlights the fact that the situation is going to change dramatically when the individual does not fall into the highest tax bracket but comes into a lower one. When this happens then actually remaining with the growth option would be the better choice because if they are coming into the 20 per cent or the 10 per cent tax bracket then the impact that they will face on the dividend option is going to be higher. Thus here if they shift or choose the dividend option then they would end up actually bearing a higher tax impact which is opposite of what they would pay when they earn short term capital gains. This also shows that the situation is not similar across all time frames but that it would vary with the conditions and that there is a need to look at all the factors carefully before they actually make a final decision.
Depending on the tax bracket the mutual fund investor should decide on the investment option.
Investors are often on the lookout to save some element of tax so they think about the choice of a dividend or the growth option in mutual funds especially debt oriented funds. There is a lot of time and effort that is spent in this regard but in many cases this might not be warranted as there might not be much of a difference. It is vital to take a close look at the entire situation and then make a decision because it should not be that there are steps which actually lead to little savings or that there is actually a negative impact due to the move. Here is a detailed look at the entire issue and how this can be handled.
Changes
There has been a change in the conditions for debt oriented mutual funds wherein the time period of holding for the fund to be considered as a long term capital asset has been increased from 12 months to 36 months. The end result has been that any sale of units before this time period will result in a short term capital gains arising to the investor and this will be taxed at the rate that will be applicable to the investor. If the investor falls into the highest tax bracket then the tax rate could go upto 30 per cent. One of the alternatives suggested to investors in such a situation is to move towards the dividend reinvestment option but this might not yield to meaningfully better results. One needs to look at the overall situation and how this works out before a final decision can be made in the matter.
Highest rate
If an investor falls into the top tax bracket which would mean that they would be paying short term capital gains at 30 per cent then there would be some minor savings that would ensure when the shift is made to the dividend reinvestment option. The first thing to understand is that while the dividend is tax free in the hands of the investor there is an indirect cost that they are paying because there is a dividend distribution tax that is present at the time of the declaration of the dividend. So even if you are not receiving a payout from the fund there is the dividend distribution tax that has to be paid and this adds to the cost element for the investor. The other thing is that the impact on the investor of this tax is going to be 28.33 per cent. So this is a high figure and if the investor is in the top tax bracket then there is a marginal amount of savings that is taking place.
Other tax brackets
This also highlights the fact that the situation is going to change dramatically when the individual does not fall into the highest tax bracket but comes into a lower one. When this happens then actually remaining with the growth option would be the better choice because if they are coming into the 20 per cent or the 10 per cent tax bracket then the impact that they will face on the dividend option is going to be higher. Thus here if they shift or choose the dividend option then they would end up actually bearing a higher tax impact which is opposite of what they would pay when they earn short term capital gains. This also shows that the situation is not similar across all time frames but that it would vary with the conditions and that there is a need to look at all the factors carefully before they actually make a final decision.
Happy Investing
Source:Moneycontrol.com
Your article gives some good information. Every one to get knowledge of any fund, before invest. Ex: What is New Fund Offer. Understanding about New Fund Offer Importance.
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