The role of mutual funds in tax planning in 2023
Managing taxes is vital to financial management, and investors have multiple ways to reduce their tax obligations. A tool that has become increasingly popular is mutual funds.
With their diversified investment portfolios and tax-efficient structures, mutual funds offer an excellent avenue for individuals to save on taxes while achieving their financial goals.
What are mutual funds?
Professionals manage mutual funds and serve as investment vehicles that bring together funds from various investors. These funds are then invested in a diversified portfolio of securities, including stocks, bonds, and money market instruments. They offer a range of schemes tailored to suit various risk profiles and investment objectives.
What is the tax on mutual funds?
Capital gains tax and equity mutual funds: Equity mutual funds hold a significant advantage in tax planning. In India, if an investor has equity mutual funds for more than one year, the gains made on their sale are considered long-term capital gains (LTCG). They are taxed at a lower rate of 10%. This makes them an attractive investment option for individuals looking to minimize their tax liabilities.
Dividend distribution tax (DDT) and debt mutual funds: Debt mutual funds also play a crucial role in tax planning. The Union Budget 2020 abolished the dividend distribution tax (DDT), making debt mutual funds more tax-efficient.
Investors now have the option to choose between growth and dividend plans, depending on their tax objectives. By opting for the growth plan, investors can defer the tax liability until the redemption or sale of the units.
Systematic investment plan (SIP) and tax savings: Investors can use the Systematic Investment Plan (SIP) to invest a fixed amount at regular intervals, making it a popular investment method. Apart from the advantage of rupee-cost averaging, SIPs can also offer tax benefits.
Investments made through SIPs in Equity Linked Saving Schemes (ELSS) are eligible for tax deductions under Section 80C of the Income Tax Act up to a limit of Rs. 1.5 lakhs. ELSS funds have a lock-in period of three years, making them an attractive option for tax planning.
Indexation benefits for debt funds: Debt mutual funds offer an additional advantage through indexation benefits. Indexation is a technique that adjusts the purchase price of an investment for inflation.
Investors can reduce their tax liabilities on long-term capital gains from debt mutual funds by considering the cost inflation index. This benefit helps mitigate inflation’s impact on returns and improve after-tax gains.
Systematic withdrawal plan (SWP) and tax efficiency: For individuals looking for regular income during retirement or other financial goals, mutual funds offer the Systematic Withdrawal Plan (SWP).
With SWP, investors can withdraw a set amount at consistent intervals. It provides tax efficiency as the capital gains from SWP are taxed only when the withdrawal exceeds the initial investment amount. This method provides a tax-efficient way to manage cash flow while minimizing the tax burden.
To wrap up
Mutual funds will continue to play a significant role in tax planning for Indian investors in 2023. Start exploring the vast opportunities that mutual funds offer and take charge of the tax planning journey today.