Mutual funds are one of the hottest options for investing because they can assist you in achieving your financial goals.
One significant downside of putting your money in a fixed deposit for investment purposes is that the interest is added to your taxable income and taxed at your income tax slab rate, which is especially unfavorable if you are in a high-income tax bracket. Here mutual funds do better financially as they can help you save some taxes.
You can benefit from specialized money management and tax-efficient returns by investing in mutual funds. Profits from investments in mutual funds are taxed in a manner similar to that of other asset classes.
By becoming knowledgeable about the taxes of mutual funds, you can set up your investments to lower your overall tax liability.
You may also benefit from tax deductions in certain situations. Keep up with the rules governing tax on mutual funds when investing in them.
Determiners of Tax on Mutual Funds
There are two categories of mutual funds: equity- and debt-oriented. Both of them are subject to different taxation.
- Dividend: A dividend is a portion of the cumulative profit that mutual fund providers distribute to scheme investors.
- Capital gains: They are the profits made when investors sell their capital assets for more money than they originally paid for them
Taxation of dividends offered by Mutual Funds
The Union Budget 2020 made changes that affect how dividends offered by any mutual fund plan are taxed. In other words, dividends that investors receive are added to their taxable income and taxed at the rates applicable to each income tax slab.
Dividends were previously exempt from tax in the hands of investors since businesses paid dividend distribution tax (DDT) before distributing their profits to investors as dividends.
Investors were not subject to tax on dividends (received from domestic enterprises) up to Rs 10 lakh per year. Any dividends that exceeded Rs 10 lakh per fiscal year were subject to a 10% dividend distribution tax.
Taxation of capital gains offered by Mutual Funds
The holding duration and kind of mutual fund affect the tax rate on capital gains for mutual funds. The holding period is the length of time an investor held units of a mutual fund.
Mutual funds offer both short and long-term capital gains, which are taxed differently
Things to remember regarding tax for mutual funds
- Mutual does not need you to pay taxes yearly. When choosing a mutual fund scheme, the appropriate taxes must be paid only when the units are redeemed or the scheme is sold. It does not factor in annually. Your dividend income from mutual fund plans is included in your overall income for the questioned fiscal year. Therefore, if your income is subject to income tax, you must pay tax on this dividend income.
- Even though you cannot avoid paying tax on capital gains, you can structure your investment in a way that minimizes your tax liability.
- Even though tax-saving mutual funds have some restrictions, you should take four things into account when choosing one. They are investment method, asset allocation, tax-exemption thresholds, and lock-in duration.
- Your investments in mutual funds may be eligible for an income tax refund. Tax benefits are available in the case of ELSS, or Equity Linked Savings Schemes, under Section 80C of the Income Tax Act. You can deduct up to Rs. 1.5 lakh from your taxes, which translates to an annual tax savings of about Rs. 46,800. Keep in mind that ELSS has a three-year minimum lock-in term.
- There are no wealth taxes imposed on mutual funds or other financial assets.
It’s important to read and study the tax guidelines for mutual funds before investing your money. Connect with a financial expert to make the right choices and make the most of your returns to achieve your financial dreams.
