Financial planning is important to realize your life goals and the process makesyou consider mutual funds as a preferred investment avenue. Individuals usually consider opting for debt funds to realize their short-term goals, a hybrid of debt and equity for medium-term goals, and equity mutual funds for long-term goals.
When it comes to financial planning, everyone loves back-of-the-envelope calculations. For instance, a person who has predeterminedtheir budget for that international trip in 2 years can divide this budget by 24 months to establish how much money they need to invest each month to fund the trip. People use this technique to calculate crucial goals like retirement too. However, there’s one ingredient missing – taxation on mutual funds! You simply cannot ignore tax on mutual funds.
Gone are those lovely days, when returns from long-term capital gains (LTCG) on equity mutual funds were exempted from tax. Now, if you sell your equity funds after holding them for a year, you are obliged to pay an LTCG tax of 10% on capital gains over Rs1 lakh made in a given financial year. What’s more, if you plan to sell your mutual fund investment before a year, the gains would be treated as short-term capital gains (STCG) and the returns would be taxed at a whopping 15%.It is only when you consider all aspects of the capital gains tax you get a clear picture of the effective returns.
Taxation impacts and affects your mutual fund investments in multiple ways. Firstly, capital gains on equity and debt mutual funds are subject to capital gains tax. Moreover, dividends might not be taxed by the investor, but dividend distribution tax (DDT) may be levied. Lastly, there are tax-saving investment options available to investors like Equity-Linked Savings Schemes (ELSS), which offer you tax benefits up to Rs1.5 lakh under Section 80C of the Income Tax Act, 1961. Under 80C, an individual can save up to Rs.46,800 each financial year by investing in ELSS.
Taxation on mutual funds
Equity mutual funds
Short-term capital gains tax:Short-term capital gains are those gains made from investments heldless than a year. These gains are taxed at 15%.
Long-term capital gains tax: Long-term capital gains are gains from investments held for more than a year. Capital gains over Rs1 lakh are taxed at 10% each financial year under LTCG tax.
Debt funds
Short-term capital gains tax: If investments are sold before the completion of 3years, the gains earned on these investments are added to the income of the investor and taxed according to the income tax slab he/she falls into.
Long-term capital gains tax:If investments are sold after 3 years, gains are taxed at 20% with indexation benefits.
Hence, you should plan your withdrawals in a way that you make optimum use of the Rs1 lakh exemption threshold every year. Hope you use these tactics to save most on taxes and ultimately on your returns. Happy Investing!