Tax Implications of SIPs in Mutual Funds

Systematic Investment Plans, or SIPs, is the finest saving mode by most investors nowadays to become rich systematically and periodically. Ease of little investments at regular intervals in mutual funds is the primary reason why new and old investors are attracted to SIPs. While all of us desire returns, most investors put one basic and glaring fact in the back seat: tax. Tax implications of SIP are a must if you want to reap the maximum from your returns and protect yourself from shockers at redemption time. In this blog, we will be defining SIP tax implications in easy words, talking about tax saving SIP schemes for tax, and making recommendations on how to utilize the best of your tax payables in a wise manner.

What is a SIP?

A Systematic Investment Plan or SIP is investing in a mutual fund where money is invested at a fixed rate for a specific sum for a particular price at regular intervals, i.e., monthly.

SIP is not about investing a huge sum of money in one go but investing regular amounts periodically for a period of time, and the money is earned by compounding returns and rupee cost averaging. SIP is a wonderful method to build money discipline and save for the future towards a big goal like purchasing a property, retirement funds, or school fees for a child.

The Tax Principle For Mutual Funds

Returns of mutual funds are taxed on the basis of nothing but fund type (equity or debt) and holding period. That's elaborated below in simple words:

Equity Funds: If the period of holding is less than 12 months, they are Short-Term Capital Gains (STCG) and taxed at 15%. If the holding period is more than 12 months, they are Long-Term Capital Gains (LTCG) and taxed at 10% on the amount over Rs. 1 lakh in a year.

Debt Funds: Total return—irrespective of holding period—is taxed at investor's income tax slab rate as per new April 2023 taxation rules. The benefit of 20% LTCG with classification is lost.

SIP Tax Impacts Explained

It is another misinterpretation that a Systematic Investment Plan (SIP) is a prepaid tax-paying. To the contrary, every installment of an SIP is a standalone investment. Consistently with this view, the holding period as well as the tax rate charged is computed separately for each SIP installment.

For instance, if you invest Rs. 5,000 in an equity mutual fund SIP and hold it for 12 months, your first installment will be eligible for LTCG after 12 months whereas your last installment would still remain STCG. Thus, if you have no choice but to withdraw the investment within 12 months, none of the units would get long-term tax benefit.

It is thus essential that the tax implications of Systematic Investment Plans (SIP) be taken seriously. It is also essential to plan the withdrawal amount and date in a manner such that the tax rate is minimized to the best possible extent.

SIPs in Equity Mutual Funds - Tax Treatment

Equity mutual funds are the most tax-efficient investment schemes. If you have invested in equity SIP for over a year, you are taxed as LTCG. Your return up to Rs. 1 lakh within a year is exempted from tax, and above that, you pay 10% tax without any categorization. For short term investment (holding period not exceeding 12 months), STCG is imposed at a flat rate of 15%. Therefore, equity SIPs need to be undertaken for the long term because tax outflow will be considerably low if investment is being held for more than one year.

SIPs in Debt Funds - Tax Treatment

With the ease in taxation rules from April 1, 2023, debt mutual funds lost their previous LTCG benefit. No matter if you possess the investment or not, return on debt SIPs is taxed as part of your income tax and charged based on your income tax slab.

Debt funds are less tax-effective for high-net-worth individuals. They hold good as long as early gains and capital safety are taken into account, thus are suitable for conservative investors.

SIP Tax Saving Schemes: ELSS Funds

If one wishes to minimize taxation while investing, Equity Linked Savings Scheme (ELSS) mutual funds are the most optimal option. ELSS mutual funds are equity category mutual funds with three-year lock-in periods and are tax exempt under Section 80C of the Income Tax Act.

You are allowed to invest Rs. 1.5 lakh each year in Equity Linked Savings Schemes (ELSS) and can potentially save tax of up to Rs. 46,800 for those who fall in the highest tax slab of 30%.

One can also initiate a Systematic Investment Plan (SIP) in ELSS schemes, and thus they are one of the popular tax saver SIP plans. Not only does one save tax, but one also accumulates wealth in the long run. It is a win-win situation for the working professionals and first-time buyers who would want to start their investment path while availing themselves of the tax benefits.

Best Practices in avoiding SIP Taxation

To maximize your SIP investments from the tax perspective, do not forget the following best practices:

Hold For Long Term: In the event that you hold SIPs in equity for a duration of more than 12 months, you can opt for the LTCG tax regime instead of STCG.

Plan the Redemptions Wisely: Apply First In, First Out (FIFO) method of taxation while redeeming.

Tax-Loss Harvesting: Where there are loss units, it will help you to source gains from other schemes by selling them.

Invest ELSS under SIP in advance: Not in March; long-term SIP investment reduces pressure and maximizes returns.

Mistakes to Be Shunned

• Taking up the notion that SIPs are tax-free perpetually.
• SIPs take money out in advance without considering the element of tax.
• Investment in debt mutual funds, ignoring slab-based taxation.
• Leaving out the lock-in period of ELSS but adding liquidity.

Conclusion

Systematic Investment Plans (SIPs) is a natural means of creating wealth; however, it is nice to be aware of the taxability that goes with it.

When you invest in debt, equity, or Equity Linked Savings Schemes (ELSS), it is nice to be aware of the taxability of returns so that you can make the right choice. By employing a correct strategy, not only can you raise investments, but also tax savings. It is comforting to realize that the problem is not really generating returns, but how much more of the saved money you can save. In case you are perplexed about the tax part of SIP investment, it is always advisable to speak with a financial planner.

For those looking to go a step further in planning their finances, platforms like Indiabulls Securities Limited can help. With their market insights, investment tools, and user-friendly platforms, managing your portfolio while being tax-efficient becomes a lot easier.

FAQs

1. Is SIP taxed annually?

No. SIPs are taxed at the withdrawal of units only. But every SIP installment does bear a period of taxation.

2. How do I save tax by doing SIPs?

ELSS mutual fund SIP provides an opportunity to avail the advantage of exclusion of tax under Section 80C of Rs. 1.5 lakh a year.

3. Is ELSS SIP more than SIP in tax benefits?

ELSS SIP provides you with the tax advantage and long-term wealth generation.

4. Am I required to pay tax on non-receipt delivery of SIPs?

There is no tax payable until the redemption date of mutual fund units.

5. Taxation of SIP redemptions?

Apply the First-In-First-Out (FIFO) basis and take into account the holding duration of each installment, thereby enabling the calculation of whether Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG) needs to be levied.

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