What Taxes Do I Pay If I Withdraw Money From A Mutual Fund?

It depends on how long you stayed invested and whether you have invested in equity mutual funds, debt mutual funds or hybrid funds.

Let's talk about Equity funds first

Equity is meant for long term investing, implying that you usually put that money in it, which you are not likely to require for the next 5-7 years at least.

However, if you decide to withdraw money sooner, specifically within 1 year of making an equity investment, then your gain will be taxed at a flat tax rate of 15% plus cess plus surcharge. If you withdraw your units of equity mutual funds within 12 months of investing then short-term capital gains will arise. This rate does not depend on your income slab.

If you withdraw from your equity mutual fund units after 12 months of holding, then a long term capital gain will arise. The long term capital gain will be taxed at 10% without the benefit of indexation. Moreover, a long term capital gain on equity mutual funds up to Rs 1 lakh is exempt from tax.

It is important to understand that only gain is taxed. This is best understood with an example.

Let's say you invested Rs 10,000. This grew to say Rs 20,000 in 4 years.

You now decide to withdraw Rs 10,000.

When you withdraw this amount, you are withdrawing both principal (Rs 5,000) and gain (Rs 5,000). Only the gain of Rs 5,000 is taxable.

Note: Long term capital gain from equities upto Rs 1 Lakh in a financial year is not taxable

In case of debt funds

You typically invest in debt MFs for your short term needs or money which you would need in the next 1-5 years.

If you withdraw from your debt funds before 3 years, the profit on the withdrawn units will be taxed at the rate for your income slab.This capital gain is known as short term capital gain.

Whereas, if you do so after 3 years, then you pay tax at the rate of 20% after indexation. And a withdrawal of units of debt mutual funds after 3 years is known as long term capital gain. In simple terms, indexation ensures that you pay tax only on the profits that exceed the rate of inflation and therefore the actual tax you pay is very little. Due to the effect of indexation your cost of acquisition of the units increases thereby decreasing the capital gains subject to taxation.

Regular monthly (SIP) investors

The period of holding is calculated separately for each month's investment and not from start or end date. So if you invest in equity mutual funds every month from January to December of 2017, in January of 2018, 1/12th of your investment will be 1 year old, another 1/12th will be 11 months old and so on, with the amount you invested in December 2017 is only 1 month old. Therefore only 1/12th of your investment is long term and the rest is short term. When you withdraw your units a FIFO first in and first out method is followed to calculate the period of holding of the units.

Takeaway

Capital gains tax can impact your gains significantly if you redeem your investment without keeping the time horizon in mind. The period of holding and the type of mutual fund determines the type of capital gain and the applicable tax rate. Whenever you plan to redeem your mutual fund investments, always make sure you consider the net gains rather than just the immediate returns achieved. If you invest in equity, hold for at least a year and in the case of debt, 3 years is ideal to minimize the tax hit (but there is no avoiding it).

Scripbox users

Scripbox tracks the possible impact of capital gains and

Alerts you at the time of withdrawal
Recommends which funds to withdraw from

So that you can make the best decision and minimise taxes.

Last updated November 11, 2021

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