What is Dividend reinvestment plan in mutual fund?

Dividend reinvestment plan in a mutual fund scheme allows an investor to re-invest the dividend amount by purchasing additional units under the scheme on behalf of the investor. Net asset value (NAV) for the dividend reinvestment option is the same as that for the dividend payout option for a given mutual fund scheme.

How dividend reinvestment plan works?

On declaration of dividend, mutual fund scheme under the dividend reinvestment plan re-invests the dividend amount on an immediate basis into units of the same scheme at the net asset value (NAV) for a given day. So, units held in the investor's mutual fund portfolio increase with every dividend. As in the dividend payout option, declaration of the dividend results in the fall in the value of NAV and hence additional units are bought at ex-dividend NAV by the fund.

Thus, similar to growth option, dividends are not received in the hands of the investors in dividend reinvestment plan and are instead ploughed back by the mutual fund entity at its end. So, the option of dividend reinvestment in a way institutes enforced discipline.

Further, the dividend reinvestment sub-option within the dividend option does not results in considerable change in the value of the investment. However, with every dividend, re-invested money is deemed as a new investment altogether.

How tax implications on Dividend reinvestment plan differ in case of debt funds and equity fund?

In case of debt funds, declaration of dividends attracts dividend distribution tax (DDT) @ 28.325%, including cess and surcharge. The levied DDT is not deducted in the hands of the investors instead the mutual fund organization deducts the amount from the distributable dividend and pays-off the remaining.

While investing in debt funds for less than a year, choice of dividend reinvestment plan in case you belong to a higher tax bracket of 30% would attract less total tax, including capital gains tax and DDT, in comparison to growth option. Else, in case you are in the tax bracket of 10% and 20%, choice of dividend-reinvestment plan would result in higher tax outgo as DDT rate is fairly higher in comparison to short term capital gains tax.

Investment into equity funds for a comparably longer time frame of over one year does not attracts either DDT or long-term capital gain tax for dividend reinvestment plan.

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