Mutual fund tax benefits: Understanding how to save on taxes

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Mutual fund tax benefits: Understanding how to save on taxes

Investing in mutual funds isn’t just about earning returns but also about how much you keep after taxes. That’s why tax planning is critical.

Whether you are investing consistently through Systematic Investment Plans (SIPs) or assessing your holdings for redemption, the way you structure and manage your mutual fund activities influences what you gain after taxes. This goes beyond simply claiming exemptions. It is about making smart decisions that safeguard and grow your capital over time.

Let’s learn how the thoughtful use of mutual funds can generate good returns and support efficient long-term tax outcomes.

Leveraging ELSS investments

Begin with the only mutual fund category that offers tax deduction under Section 80C, i.e., Equity-Linked Savings Scheme (ELSS). Up to ₹1.5 lakh invested in ELSS funds in a fiscal year is eligible for a tax deduction. For investors in the 30% tax bracket, that is a tax saving of ₹46,800.

Look at the features that make ELSS stand out:

• The lock-in period is just three years (the shortest amongst Section 80C investments)
• Potential to offer strong returns through equity exposure
• Investments are possible via SIPs and lump sums

It is evident that ELSS doesn’t just help you save taxes but also builds long-term wealth.

Saving taxes by selling mutual funds smartly 

You can also reduce your tax outgo based on how and when you sell your mutual fund units.

For equity mutual funds

In case you redeem units after one year, the gains are classified as Long-Term Capital Gains (LTCG). You are not required to pay any taxes on gains up to ₹1.25 lakh per financial year. Gains beyond that threshold are taxed at a flat rate of 12.5%. Selling before one year triggers Short-Term Capital Gains (STCG) taxed at 20%, which can cut down your profits.

For SIPs

Many Indians invest in the best mutual funds through SIPs, and that is a smart financial move. But remember that each monthly instalment counts as a separate investment. Units follow the First In, First Out (FIFO) method, and only the SIPs older than one year will enjoy LTCG treatment. A high-value redemption, if done without verifying SIP holding timelines, can lead to a portion of your gains being taxed at higher short-term rates.

So, it is advisable to plan redemptions wisely and track holding periods so you can retain more of your earnings, reduce tax, and improve net returns.

Tips to save tax on mutual fund dividends

Prior to April 2020, dividends from mutual fund investments were tax-free for investors. Now, mutual fund dividends are taxable in the hands of investors as per their applicable income tax slab rates. So, if you are in the 30% tax bracket, a ₹7,000 dividend means you may get around ₹4,900 after tax.

To minimise the impact of taxes on dividends, you can select the “growth” option instead of the dividend payout. In this plan, your returns remain invested and are taxed upon redemption only.

Key takeaways

Mutual funds not only offer an opportunity to earn good returns but also help you save tax when used strategically. You can utilise ELSS to claim deductions under Section 80C, go for growth options instead of dividends, and time redemptions smartly to benefit from long-term capital gains rates. While SIPs provide flexibility, knowing how each instalment is taxed enables you to manage it better.

So, make tax planning a part of your strategy and enhance the real value of your investments over time.