Make sure you choose a scheme that invests in high-quality assets
Typically, when it comes to making gradual and staggered investments in mutual funds, experts recommend opting for a systematic transfer or systematic investment plans. But for those who invest significantly in debt funds and want a flavour of equity schemes in their portfolios, there is one more option to invest at a staggered pace. It’s called the dividend transfer plan. Most fund houses offer dividend transfer plans.
First, you invest a lump-sum in a debt fund. Choose the dividend payout option. Preferably, choose the monthly or quarterly option, as that way the dividend payouts from your debt fund are a bit more regular and so would your investments in the chosen equity fund. You can also choose an arbitrage fund as the source scheme.
At the same time, choose the fund in which you wish to re-invest your dividend proceeds, preferably an equity scheme. Since the dividend transfer plan (DTP) works only if you choose both the source and target schemes from the same fund house, your form will need to you to mention both these schemes. The destination scheme can be a well-diversified multi-cap equity fund with a good track record. The source scheme declares dividends when the net asset value appreciates. Such dividends are invested in an equity fund. An investor’s capital is insulated as the funds are parked in a debt scheme.
Minimum dividend norm
Each mutual fund scheme comes with a minimum dividend payout amount of, say Rs 500. Anything less than that doesn’t get distributed. In such cases, the DTP does not get triggered.
Make sure that you put some minimum balance in your equity fund separately, when you start a DTP. All equity funds have a minimum investment threshold. Subsequent investments are generally allowed.
TDS on dividends
Since April 1, 2020 the tax on dividends paid by debt funds has been abolished. But the dividends announced by mutual fund schemes are taxable in the hands of investors. Tax is deducted at source at the rate of 10 per cent on dividends, when the dividends exceed Rs 5000 in a financial year. Besides, dividends are also taxable in your hands, as per your income-tax brackets. Even if you have opted for DTP and your debt fund dividends declared get automatically re-invested in the equity fund, you still have to pay tax on dividends declared. TDS on dividend does not absolve you of your their tax liability.
Avoid risky debt funds for DTP
Since the aim of DTP is to protect your capital by investing in a debt fund, make sure you choose a scheme that invests in high-quality assets. If you choose a risky scheme and there is a downgrade, you may end up losing your capital in the debt fund.
Investors must set the expectations right while investing through DTP in a falling interest rate scenario. As the interest rates decrease, interest income, which is a primary source of dividend, also goes down.“DTP may work for conservative investors looking for capital protection, but they must understand that the amount and frequency are uncertain and, to that extent, their investments in equity funds will not be as disciplined as a systematic transfer plan or a systematic investment plan,” says Pankaj Mathpal, founder and managing director, Optima Money Managers.