Don’t ignore taxes while investing in mutual funds to achieve goals

Don’t ignore taxes while investing in mutual funds to achieve goals

Mutual funds are well-known tax-saving investment avenues and are regarded in high esteem bynew and expert investors alike. In the last decade, they have gained a good deal of traction due to the benefits they offer, such as high returns, improved flexibility and diversification. However, many investors fail to account for taxation while investing in mutual funds as part of their financial planning.

This article can help you understand the impact of tax on your earned returns from mutual fund schemes.

Taxation on equity mutual funds

Till January 31, 2018, long term capital gains (LTCG) on equity funds were exempt from tax. But, from April 1, 2018, there has been a change. If you sell equity mutual funds after a year, LTCG of 10% on returns is levied if the gains exceed Rs.1 lakh in a financial year. On the other hand, if you sell equity funds before a year, short term capital gains (STCG) are taxed at 15%.

Taxation on debt mutual funds

If you sell debt funds before three years, the gains are treated as STCG and added to your income. They are taxed at the income tax slab applicable to you. For an individual in the highest tax bracket, this means taxation at 30% on short-term debt fund investments.

On the other hand, if you sell debt funds after three years, the gains are treated as LTCG. They are taxed at 20% after providing indexation benefit. The indexation brings down taxes by inflating the purchase cost.

Let us understand how indexation calculations work with the help of an example.

Say, in F.Y. 2015-16, Mr. X invested Rs.100 in a debt fund. After three years, he sold it in F.Y. 2018-19 for Rs.150. The Cost Inflation Index for F.Y. 2015-16 and F.Y. 2018-19 are 254 and 280 respectively.

For taxation purposes, Mr. X’s purchase price would have to be adjusted for inflation and raised to Rs.110 (280/254)*100. As a result, his tax gains are Rs.150 – Rs.110 i.e. Rs.40.

Here, LTCG would amount to 20% of 40 i.e. Rs.8. If not for the indexation benefit, LTCG gains on the original purchase cost would have been Rs.10 (20% of 50).

Imagine the impact if you invest for a long-term horizon without considering taxation. It could eat into your corpus or earnings you plan to achieve over a short tenure. Thus, to maximise your benefits of mutual funds, factor in the taxation while investing whether for short-term or long-term.

Conclusion

If you are a beginner investor wondering where to invest money, you can consider tax saving mutual funds to save tax and create wealth in the long run. Remember, LTCG on equity funds are taxed at 10% if the gains exceed Rs.1 lakh whereas STCG is taxed at 15%. For debt funds, STCG is taxable as per your income tax slab whereas LTCG is taxed at 20% with indexation benefit.

Sheri Croll