Mutual funds are gaining popularity as a strong investment vehicle. More and more people are seeing it as an effective way to build wealth. However, one thing I’ve noticed interacting with my clients is that there’s very little clarity on the tax implications of mutual funds.
First-time investors or people filing their ITR for the first time after investing in mutual funds are literally clueless about how the investment will affect their tax liability. Ironically, having a clear understanding of tax implications is very important to make informed investment decisions.
That’s why, in this blog, I’ve discussed mutual fund taxation and tax-saving strategies—without jargon.
Understanding the Tax implication of Mutual Funds
Before you choose to invest in mutual funds it is important that you understand how the returns will be taxed. You must know that the profit you earn when you sell mutual fund units is categorized as ‘capital gains’ for the purpose of taxation.
The tax treatment of your capital gain from mutual funds depends on two factors –
- The type of mutual fund (Equity or Debt)
- The period for which you hold the investment (Short term or Long term)
Types of Mutual Funds and Their Taxation
Mutual funds are broadly classified as Equity mutual funds and Debt mutual funds, and each is taxed differently.
Equity Mutual Funds (Funds that invest a minimum of 65% in stocks)
- Short-Term Capital Gains (STCG) – Equity mutual fund units, if sold within 1 year of investment, are taxed at 20%.
- Long-Term Capital Gains (LTCG) – When you sell your equity mutual fund after 1 year, you attract a tax of 12.5% on the capital gain exceeding 1.25 lakh per financial year.
Debt Mutual Funds (Funds that invest in bonds, government securities, etc.)
- Short-Term Capital Gains (STCG) – The profit you earn by selling your debt fund units within 3 years of investment is considered short-term and is taxed based on your tax slab rate.
- Long-Term Capital Gains (LTCG) – When you sell your debt fund units after a period of 3 years your gains are taxed at 20% with indexation benefits (adjusted for inflation)
Strategic Tax Planning for Mutual Funds
I understand this very well that just having the information about tax percentages or slabs won’t help you practically as an investor. You also need to understand how to utilize this information to reduce your tax liabilities smartly. So, here you go –
Plan Your Holding Period Wisely
- Plan your investment in such a way that you hold your equity mutual fund investment for more than 1 year. This will minimize your tax liability as it will become a long-term gain.
- Similarly, you should plan in such a way that you hold your debt fund investment for more than 3 years or more. This way you’ll get the indexation benefit thus reducing overall tax outgo.
Utilize Tax-Loss Harvesting
Tax-loss harvesting is another effective way to minimize tax liability when some of your mutual fund investments are making losses.
You can utilize the losses from other mutual fund investments to offset capital gains from other investments.
Utilize Section 80-C for Tax Saving
A very popular method of saving tax includes Section 80-C under which investors can claim deductions of up to ₹1.5 lakh annually on taxable income. And this can be done by investing in Equity-Linked Savings Schemes (ELSS) that come with a mandatory 3-year lock-in period.
Here, you must remember that long-term capital gains exceeding ₹1 lakh are taxed at 10%.
My Take
Taxes play an important role in determining the net return or the actual gain you receive from any investment. That’s why understanding tax implications before making investment decisions is essential.
All this may seem overwhelming at first, but with the right guidance, strategic tax planning is not very complex. You can lower your tax liability and maximize your gains without hassle if you working with an experienced financial advisor.
And you already know – whenever you need hand-holding, team MoneyAnna is always here to help! Grow your money wisely.
