We all make investments with an aim to enjoy capital appreciation and build a huge corpus in the long run. Mutual funds are one such investment channel that has the potential to offer capital appreciation in the long term horizon. Therefore, you must have always heard financial advisors suggesting the importance of investing in mutual funds. In fact, mutual fund investment is a great way to begin your investment journey.
While we carefully plan our investments, one aspect which is often ignored is mutual fund taxation. Mutual fund taxation rules can get slightly confusing for a layman. However, if you have a mutual fund portfolio, it is imperative that you have a good understanding of how your returns will be taxed.
Tax on mutual funds majorly depends on factors such as the type of fund you have invested in, your investment duration, your income tax slab and so on. This article helps you understand the taxation rules for mutual funds and how mutual fund taxation impacts your overall returns.
Mutual Fund Taxation
When you invest in mutual funds, you make profits in the capital investment in two ways – through capital appreciation and dividend receipts. The mutual fund house or Asset Management Company declares dividends on the equity funds appreciation and dividend receipts. The fund house declares dividends in the event of equity funds as and when the fund makes earnings. Likewise, on debt funds, you receive regular interest at a set rate. With these earnings, the value of your mutual fund investment continues to grow. At the same time, it attracts capital gains that tend to be taxable to investors.
Understanding Capital Gain on Mutual Fund
Capital gain is nothing but the profit that you make on your mutual fund investment when you redeem or sell your mutual fund units. In simple words, it is the difference between the value at which you purchased the mutual fund units and the value at which you are going to sell or redeem them.
For example, let us say, Mr. Rohan invested Rs. 2 lakh in a mutual fund scheme on 1st January 2017 and the value of his investment on 1st January 2020 is Rs. 2.5 lakh. In this case, Mr. Rohan has earned a capital gain of Rs. 50,000.
Taxation of Capital Gain on Mutual Fund
The capital gains tax on mutual funds depends on the type of mutual fund scheme and the investment duration.
The duration over which an investor stays invested in a mutual fund scheme is called the holding period. It plays a crucial role in determining the tax implication on the mutual fund investment. Depending upon the holding period, capital gains tax can be classified into two types – Short term capital gains tax (STCG) and long term capital gains tax (LTCG).
- Short-Term Holding Period
Equity funds and equity-oriented hybrid funds are taxable for the short term if the holding period is less than 12 months. On the other hand, debt-oriented hybrid funds and debt funds are taxable as short term if the holding period is less than 36 months.
- Long-Term Holding Period
Holding equity funds or equity-oriented funds for more than 12 months is termed as long term. But in the case of debt funds, the investment is termed as long term only if the holding period is 36 months or more.
If the mutual fund is a hybrid equity oriented fund where the exposure of equity is more than 65%, it will be considered as an equity fund for mutual fund taxation. However, when the exposure of the hybrid fund is less than 65% towards equity or it is 50% debt and 50% equity, in such case, the fund shall be considered as debt fund for taxation purpose.
Let us now learn about mutual fund taxation rates.
Mutual Fund Taxation Rates
- Equity Oriented Mutual Fund Schemes
The mutual fund taxation rates for equity-oriented schemes with a holding period of up to 12 months are taxable for short term capital gains at the rate of 15%. If the holding period is more than 12 months, the long term taxation rate is 10%. The long term capital gains are exempt up to Rs. 1 lakh per annum for investing in equity-oriented mutual funds.
- Non-Equity Oriented Schemes
The mutual fund taxation rates for non-equity oriented schemes with a holding period of up to 36 months are taxable for short term capital gains at the rate of investor’s tax slab. If the holding period is more than 36 months, the long term taxation rate is 20% after indexation.
Apart from the above-mentioned capital gains rates, the investor now has to pay tax on the dividend income as per his personal income tax slab rate. Prior to the budget 2020, the fund house (Asset Management Company) was supposed to to pay Dividend Distribution Tax (DDT) on the dividends on mutual funds on behalf of the investors. Another type of tax known as Securities Transaction Tax (STT) is applicable on the sale of mutual fund units in balanced and equity funds. It is applicable to both close-ended and open-ended schemes.
Since taxes take away a major portion of your corpus that you need to meet your financial goals, it is important that you include the tax on mutual funds in your calculation while doing financial planning. Investing in mutual funds is an art and you will master it with time. While deciding to invest, you must consider a few factors such as your investment goals, risk appetite, investment horizon and returns expectation before making any decision.
Acquiring knowledge about mutual funds can help you go a long way. You can read from the vast information available on the internet or you can seek expert advice. If you need any assistance regarding mutual fund investment or taxation on mutual funds, you can contact IndiaNivesh.
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
Step up SIPs Systematic Investment Plans, or SIPs, are very popular as they allow you a disciplined approach to investing in mutual fund schemes. You can start a SIP in any mutual fund scheme that you prefer and invest periodically affordable amounts to build up a substantial corpus over a long term period. SIPs offer you the benefits of – Affordable investments Disciplined investments and Rupee cost averaging When you invest through SIP, you choose a fixed amount of money that would be invested at periodic intervals. But what if you want to increase the SIP amount? Can you do so in the existing ongoing SIP investment? For doing that you may have to start a fresh SIP for the additional amount. The current SIP amount would not be allowed to increase unless you have opted for “Step up” feature at the time of starting your SIP investment. Let’s understand what this feature is all about. What is a step-up SIP? A step-up SIP, also called a top-up SIP, is a type of SIP investment wherein you can increase your monthly SIP investment amount periodically at a fixed rate. A step-up SIP, therefore, allows you to increase your mutual fund investments as your income grows. How does a step-up SIP work? A step-up SIP increases your monthly SIP investments in any of the following two modes – By a fixed amount By a fixed percentage When you invest in a step-up SIP scheme, you have to specify which increment mode you prefer, the amount or rate of increase, the frequency of increase (annually or monthly) and the time up to which the increase should be done. When all the details are provided, your SIP commences and then increases at the defined rate and at the defined interval. Let’s understand the working of a step-up SIP by an example – Suppose you choose a step-up SIP of INR 5000 due every month. You choose to increase the SIP by 10% every year for up to 10 years. In this case, when you start the SIP, the first year, your investments would be done @ INR 5000 every month. Thereafter, in the next year, the SIP amount would increase to INR 5500. In the third year, the SIP amount would again increase to INR 6050, and so on. Alternatively, you could choose to increase the SIP by a fixed amount of INR 1000 every year rather than a fixed percentage. In that case, your SIP in the first year would be INR 5000 per month. In the second year, it would increase to INR 6000, then INR 7000, and so on. Thus, under the step-up SIP scheme, your SIP amount would increase by a specified amount every year, allowing you to step-up your investments over time. You can also specify a maximum SIP amount, which would serve as the maximum limit to which the SIP would increase over time. When the increased SIP reaches the maximum specified amount, no more increase would be affected, and your investments would continue at the maximum amount. Benefits of step-up SIPs Step-up SIPs prove beneficial than conventional SIPs because of the advantages that these schemes provide. Such advantages are as follows – You can sync your investments with increasing income During your active working life, your income does not remain stagnant at one level. It increases with the increase in your experience and your appraisals. When your income increases over time, why shouldn’t your SIP increase too? Step-up SIPs allow you to effortlessly increase your investments so that your increasing income is saved to yield an increased corpus. You can accumulate a higher corpus As you increase your SIP investments, your corpus grows. Step-up SIPs allow you to increase your savings even when you are a passive investor. Your marginal propensity to save increases as your income increases through step-up SIPs. A slight increase in your SIP investment can help you meet your financial goals faster. It helps you face inflated costs The higher corpus which you can avail through step-up SIPs also allows you to meet the increased cost of living due to inflation. As inflation raises the cost of goods and services, the corpus that you accumulate through step-up SIPs allow you to meet such inflated costs without any difficulty. It results in disciplined savings Ideally, as your income grows, so should your investments. However, this is seldom the case. As incomes increase, many individuals squander their money in unnecessary indulgences rather than in savings. Step-up SIPs ensure that a part of the increased income is directed to disciplined investments so that you are not tempted to spend your earnings mindlessly. It is convenient Rather than looking for different fund options for a new SIP to boost up your investments, a step-up SIP allows you to increase your investments through the existing fund itself. Step-up SIPs, therefore, provide you with the convenience of managing a handful of funds as you don't have to manage and monitor multiple mutual fund schemes for enhanced investments. Step-up SIPs, therefore, are the ideal solution for increasing your investments over time as your income increases. It is a smart saving solution if you want to create a higher corpus for your life’s goals. Beginners can choose step-up SIPs to start investing small, affordable amounts as they start their mutual fund portfolio and then gradually increase their investments as their income and knowledge grows. So, make your SIP investments dynamic through step-up SIPs. Find out some of the best performing step-up SIPs at IndiaNivesh, and we promise you expert assistance with your mutual fund investments. Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
Mutual funds can make an excellent addition to your investment portfolio. However, if the mutual fund is yielding less returns than what you anticipated, you might get tempted to sell off your mutual fund units and invest the funds in other better yielding investment avenues. If you decide to make an exit from your mutual fund investment, you may do so by redeeming the units you hold. Selling mutual funds is known as mutual fund redemption. However, when you decide to sell mutual funds, you must access all the pros and cons and get a good understanding of when to sell mutual funds and how to sell mutual funds. Besides, mutual fund selling techniques play a crucial role in selling mutual funds. This article helps you in understanding various aspects of how to sell mutual funds and its related concepts. There are four steps for selling mutual funds, let us learn the steps in detail. How to Sell Mutual Funds Contact the Mutual Fund Company or Financial Advisor If you have purchased the mutual funds from the mutual fund company directly, you must contact them directly. On the other hand, if the purchase is made with the assistance of a financial advisor, you can contact the advisor or his company. Check the Fees or Charges of Selling Mutual Funds Before selling your mutual fund units, check the fees or charges that are applicable. The charges on selling mutual funds depend on the period of your holding, the company with whom you are dealing and the size of the sale. For example, if the purchase of mutual fund units is made with a deferred sales charge, you will have to pay a sales charge on it. The companies selling the mutual fund units with deferred sales charges often allow the holders to sell up to 10% of units without any charge. Decide the Number of Units to Sell For selling the specific number of units of mutual funds, you have to submit a signed form to the respective authority. The confirmation letter signed by you ensures that no one else can sell more or less number of units than specified. The selling price of the mutual fund units is NAV of your fund. Instruct About the Money Received on Selling Units When you sell your mutual fund units through the company or advisor, you can give them instructions regarding what to do with the money. You can ask for a cheque or instruct them to deposit the money into your bank account. You can even use the money to purchase other mutual fund units or investment. The above mentioned is the process of selling a mutual fund. Along with how to sell mutual funds, you must know when to sell mutual funds. In this section of the article, you will learn about the right time to sell a mutual fund. When to Sell Mutual Funds Change in Fund Manager The expertise and experience of the fund manager is the first and foremost thing to consider before investing in any mutual fund. Fund managers help in generating wealth. But when a mutual fund company changes its fund manager for any reason, it’s the time to get cautious. It becomes important to check the expertise and knowledge of the new fund manager. If he does not fulfil your criteria, it is probably the time to sell your mutual fund units. Change in Strategy You invest in any mutual fund after determining your financial goals. When mutual fund’s strategy meets your financial goals, you feel more confident and comfortable about your investments. But when the mutual fund company starts changing its investment strategy and that is against your approach, you may think of exiting such mutual fund. Underperformance When the mutual fund is not giving the returns you expect out of it even after holding it for the long term, it is probably the time to exit. The best way to know the performance of your fund is by comparing it with other similar funds. If your fund is underperforming, it is not a good sign. Rebalancing If you have a set asset model and you rebalance it at the end of each year, you may need to sell your mutual fund units. You may also think of selling the mutual fund units when your investment goals change and there is a need for rebalancing. Like for example, if you were following a growth strategy and now want to change it to a strategy that provides a steady income, in that case, you may have to sell your mutual fund units to fit in the new strategy. Conclusion The above mentioned are a few of the situations when you may think of selling a mutual fund. However, selling mutual funds should not be an impulsive decision. It is imperative to think wisely and act smartly. Always remember that initially when you decided to invest in mutual funds, you had a positive outlook and that is why you decided to invest. Hence, make sure that your reason to exit is clear. It is ideal to carefully analyse all the pros and cons of your fund's performance and then decide when to sell mutual funds and how to sell mutual funds. Once you gain confidence in your decision, don’t hold back. If you need any assistance regarding investing in mutual funds or any other asset class, you may seek the expert advice of IndiaNivesh. Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
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