How to avoid LTCG (Long Term Capital Gains) Tax on Mutual Funds

Long-term capital gains (LTCG) tax can take a bite out of your mutual fund returns. But don’t worry! There are smart ways to minimise or even avoid this tax legally. This blog will share easy and effective strategies to help you save more on taxes and grow your wealth. 

Whether you’re experienced in investing or new to it, these tips are easy to grasp and implement. Let’s dive in!

What is LTCG Tax on Mutual Funds?

LTCG refers to Long-Term Capital Gains, which are the profits earned from selling mutual fund units held for over a year. In India, such gains are taxable if they exceed ₹1 lakh annually, with a tax rate of 10% applicable to equity mutual funds.

Here’s a simple example: If you bought mutual fund units for ₹2 lakhs and sold them for ₹3.5 lakhs after holding them for over a year, your gain is ₹1.5 lakhs. Since the first ₹1 lakh is exempt, you’ll only pay tax on ₹50,000. The tax would be ₹5,000 (which is 10% of ₹50,000).

Understanding LTCG tax is important because it affects how much profit you actually get to keep. It’s a way for the government to collect revenue from your investment profits. However, with proper planning, you can manage and minimise this tax. 

Strategies like spreading out your redemptions or investing in tax-saving mutual funds can help you make the most of your investments while keeping your tax bill as low as possible.

How to Avoid LTCG Tax on Mutual Funds

Long-Term Capital Gains (LTCG) tax can reduce the profits you make from mutual funds. But, with a few smart strategies, you can avoid or minimise this tax legally. Here are some simple ways to do it:

Utilise the ₹1 Lakh Exemption

The Indian government allows you to earn up to ₹1 lakh in long-term capital gains each financial year without paying any tax. To make the most of this, plan your withdrawals. If your gains are close to ₹1 lakh, try to spread out your redemptions over multiple years. This way, you can keep your gains within the tax-free limit.

Invest in Tax-Saving Mutual Funds

Equity-Linked Savings Schemes (ELSS) are advantageous due to their tax benefits under Section 80C of the Income Tax Act. While ELSS returns are subject to LTCG tax, investors can claim a tax deduction of up to ₹1.5 lakh on their initial investment, effectively lowering their total tax burden.

Use Systematic Withdrawal Plan (SWP)

An SWP allows you to withdraw a fixed amount from your mutual fund investment regularly, like monthly or quarterly. By doing this, you can spread your gains over several years. This might help you stay within the ₹1 lakh exemption limit each year, minimising the tax you pay.

Hold Your Investments for the Long Term

Holding your investments for a longer period can help you avoid frequent taxable events. The longer you hold, the more your investment benefits from compounding returns. Additionally, fewer transactions mean fewer instances where you need to pay taxes.

Harvesting Losses

If you have mutual fund investments that are currently showing losses, selling them can be a strategic move to offset gains from other investments. This approach, called tax-loss harvesting, can effectively lower your taxable gains and, as a result, reduce your overall tax liability.

Why Holding on to Your Investment is a Better Option?

When it comes to investing in mutual funds, patience can be your best friend. Holding on to your investment for a longer period has several benefits that can help you grow your wealth more effectively. Here’s why it’s often better to stay invested for the long term:

Benefit from Compounding

One of the biggest advantages of holding your investments is the power of compounding. Compounding means earning returns on your returns. The longer your money stays invested, the more it can grow. 

For example, if you earn returns on your initial investment, those returns start earning more returns, creating a snowball effect.

Smooth Out Market Fluctuations

Markets go up and down all the time. If you react to every dip and rise, you might end up making decisions that hurt your long-term gains. By holding on to your investments, you can ride out the short-term volatility. 

Over time, the overall trend of the market tends to be upward, which means your investment is likely to grow if you stay invested.

Tax Efficiency

Every time you sell a mutual fund unit, you might have to pay taxes on the gains. By holding your investment longer, you reduce the number of taxable events. This means you pay taxes less frequently, which can help you keep more of your returns. 

Additionally, long-term capital gains (LTCG) tax is generally lower than short-term capital gains tax, making long-term holding more tax-efficient.

Lower Transaction Costs

Buying and selling mutual funds involves costs such as transaction fees and exit loads. If you trade frequently, these costs can add up and eat into your returns. By holding your investments, you avoid these costs, allowing your money to grow more efficiently.

Achieve Long-Term Goals

Investments in mutual funds are often made with long-term goals in mind, like buying a house, funding education, or planning for retirement. Staying invested helps you achieve these goals more effectively. It allows your investment to grow steadily over time, aligning with your long-term financial objectives.

Conclusion

Avoiding LTCG tax on mutual funds is about smart planning and strategic investments. By utilising exemptions, investing in tax-saving funds, and holding your investments longer, you can minimise your tax burden and maximise your returns. Keep in mind, the objective is to increase your wealth effectively and within legal boundaries.