As in stocks and insurance, dividend or bonus payments accrue to an investor or policyholder from the profits realized from selling their holdings, same is the case is for mutual funds. This is true for both equity and debt mutual funds. It is not the unrealized profits from the instrument from which the dividends can be paid out.
Though in general, the investors get inclined to the dividend pay out option with the mutual funds, neither there is a guarantee of the payment nor the amount or frequency of the dividend is pre-assured to the investors and the decision lies solely with the fund house.
Retirees or people close to their sun-set years look for a stream of cash flow and hence get drawn away with this plan.
Understanding dividend pay out in mutual fund plans
In a case when you buy a fund unit at a cost of say Rs. 10 and then it as a result of appreciation moves high by say Rs. 5 then this extra earning by the fund house can be in full or partial amount distributed as dividend to investors. In doing so, after the dividend pay-out is paid, the NAV of the fund may retreat back to lower levels.
Also, in a case when taking the SIP route for some financial goal it is suggested to go with growth option instead of the dividend plan as then through the dividend pay-out the compounding benefit gets reduced to an extent.
Taxation of equity and debt dividend mutual fund plans
No direct tax implications befall on the investors on dividend payment but at the same time they are not completely rescued and have to bear a part as fund houses on equity dividend plans need to 10% as DDT and on the debt mutual funds the tax rate come as 28.84% which includes surcharge and cess.