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Don’t ignore taxes while investing in mutual funds to achieve goals : 01 Nov 2019

Capitalstars Investment Adviser

Gone are the days when long-term capital gains on equity mutual funds were tax-exempt. Now, if you sell your equity mutual funds after a year, you must pay a long-term capital gains tax.

Everyone loves rough calculations or the back of the envelope calculations when it comes to financial planning. For example, a person would decide the budget of a foreign holiday she is planning after three years and divides the amount by 36 months to find out how much she needs to invest to fund her holiday. Even when it comes to a crucial goal like retirement, the strategy remains the same. The required investment is calculated with the PMT formula in an Excel sheet. The required investment is calculated with PMT formula in an Excel sheet. An important ingredient that is missing in these calculations is the tax on returns from mutual funds.

Now, if you sell your equity mutual funds after a year, you must pay a long-term capital gains tax of 10 percent on returns of over Rs 1 lakh in a financial year. If you sell your equity mutual funds before a year, the gains are treated as short-term capital gains and taxed at 15 percent.

On the other hand, if you sell your debt mutual fund investments after three years, your returns are treated as long-term capital gains. Such gains are taxed at 20 percent with indexation benefit. The indexation benefit helps to inflate the purchase cost and it brings down the taxes considerably in an inflationary scenario.

Now, why should you include these taxes in your calculations? Simple, because the taxes take away a part of the corpus you need to meet your goals. For example, your fund for the foreign holiday next year will take a hit because of the short-term capital gains tax on debt mutual funds. Your returns would be taxed at 30 percent when you sell your debt mutual funds. If you do not account for the taxes, you might face a shortfall.

The long-term capital gains tax of 10 percent on equity mutual funds is even more crucial on your long-term financial goals. Since you are investing for a very long period for your long-term goals, the returns would be substantial and even the tax outgo would be sizeable.

That is why it is important to plan your withdrawals in such a way to make full use of the Rs 1 lakh exemption limit every year. Remember, long-term capital gains on equity mutual funds of over Rs 1 lakh in a financial year is taxed at 10 percent.

Taxation of mutual funds

Equity mutual funds:

Short term capital gains tax: if investments are sold before a year, gains are treated as short-term capital gains and taxed at 15 percent.

Long term capital gains tax: if investments are sold af
ter a year, gains of over Rs 1 lakh in a financial year is taxed at 10 percent

Debt mutual funds:

Short term capital gains tax: if investments are sold before three years, gains are added to the income and taxed according to the income tax slab applicable to the investor.

Long term capital gains tax: if investments are sold after three years, gains are taxed at 20 percent with indexation benefit.


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