Switching Mutual Funds: Benefits, and Tax Implications

Q: 1. Can you make a partial switch to a new fund scheme?

Ans. Mutual funds allow investors to switch units fully or partially depending on their investment goals.

Q: 2. Is switching mutual funds taxable?

Ans. Yes, switching mutual funds is taxable. It incurs capital gains tax, which can be short-term or long-term depending on the fund’s duration.

Q: 3. What are the factors to consider before switching in mutual funds?

Ans. The important factors to consider when switching between mutual funds are the exit load, capital gains tax, and the performance of the new fund.

Q: 4. What are the rules for switching mutual funds?

Ans. Here are a few rules to consider before making a mutual fund switch:1. Firstly, you must decide whether to switch within the same scheme or to a different one.2. Make sure you meet the investment criteria for intra-scheme switches.3. Know about exit loads and capital gains taxes, and be prepared for it.4. Now, you can sell your current fund and apply for redemption.5. Further, mutual fund capital gains are taxed, with short-term gains at 20% and long-term gains at 12.5%.6. Lastly, note any lock-in periods, like the 3-year lock-in for ELSS, which limits switching before completion.

Q: 5. Is it better to switch or redeem a mutual fund?

Ans. Your overall investment strategy matters when switching or redeeming mutual funds. A switch directly moves investments from one fund to another, allowing investors to keep their investment strategy intact. On the other hand, redemption involves selling the assets and incurring taxes before reinvesting the amount into a different fund.If you want to avoid the inconvenience of redemption and reinvest the amount in another scheme immediately, then switching is the better option.

Q: 6. What happens when you switch mutual funds?

Ans. When you switch mutual funds, it helps you exit underperforming schemes and enter ones that align with your investment objectives. With the correct choices, switching can result in higher returns.

Are you thinking about transforming your portfolio? Switching Mutual Funds can play a significant role in rebalancing your portfolio. Let’s first understand the concept of switching mutual funds in detail.

Switching in mutual fund refers to transferring funds from one investment plan to another within the same Asset Management Company (AMC). This allows investors to reallocate their investments based on their changing financial objectives and market conditions.

Sometimes, you may need to switch from one mutual fund scheme to another or from a regular to a direct plan to achieve your financial goals. Switching mutual funds is not complex, but you should know certain factors, rules, charges, and tax implications.

Mutual Fund Switching is a simple technique of transferring funds from one investment scheme to another to boost returns or manage risk. Switching mutual funds allows investors to rebalance their portfolios and attain better returns. Switching mutual funds also helps investors dodge the trouble of redeeming and reinvesting in a different scheme. So, it is essential to consider the associated costs and potential benefits before switching.

How Mutual Fund Switching Works?

Switching in mutual funds is the process of switching an investment from one fund to another in the same fund house. However, it will be treated as a sell transaction in the initial scheme and a fresh purchase in the new one. Certain costs, such as exit loads and taxes on capital gains, will be charged depending on the investment period and the kind of fund involved.

In open-ended mutual funds, the switching feature is available to investors and can implemented by using the fund house’s online platform or through an agent. Switching can also be partial, where a section of your investment is shifted, or complete, where the total investment is moved.

Benefits of Switching in Mutual Funds

Switching in mutual funds can be beneficial as it permits reallocating funds within or between funds, successfully reducing liability related to underachieving assets.

Here are some benefits of switching in mutual funds

Rebalancing of Assets

Rebalancing of assets is a process of adjusting your portfolio to keep a certain asset allocation on the basis of your financial objectives and risk tolerance. If your original asset allocation was half equity and half debt, but the debt portion has outperformed, it may tilt your portfolio toward debt. A switch can restore your desired balance, ensuring your investments match your financial goals.

Enhanced Performance

Investors can relocate from underachieving assets to higher-performing ones, utilising benchmarks like CAGR and XIRR to determine asset growth and identify long-term investments with maximum returns on maturity.

Opt for Lower-Cost or Direct Plans

Direct plans have no third-party fees and usually offer higher returns than regular plans, which charge commissions. If you’re investing in regular mutual funds through a distributor, you may want to consider switching to direct plans. By switching to a direct plan, you can improve the total return on your investment.

Also Read: Best Mutual Funds to Invest in Long Term 2025

When Should You Consider a Mutual Fund Switch?

Switching mutual funds is tricky as you must be careful about the market fluctuations. Here are some situations in which switching can be a great option:

Underperformance of Funds

If your current funds are continuously underperforming and cannot keep up with the benchmark or similar funds, switch to different funds.

Change in Investment Goals

Your investment goals also get affected by circumstantial changes. If your tolerance of uncertainty decreases, i.e., risk decreases or your financial goals change, switching to a more appropriate fund can help you match your portfolio accordingly.

Fund Management Changes

A shift in the fund manager may have a significant impact on fund performance. In case, the new approach does not match your investment philosophy, switching might be necessary.

Tax Implications of Switching Between Mutual Funds

When investors switch between mutual funds, it is considered a redemption and a new investment. This makes mutual fund switching taxable. How much tax liability investors must pay will depend on the type and period the fund investors switch from and to which fund they shift to.

Here are the tax rates effective for different types of funds:

Equity Funds: These funds mainly invest in equity instruments. Switching from an equity fund before one year charges 20% of short-term capital gains tax. But you will have to pay long-term capital gains tax at 12.5% on the gains exceeding Rs. 1.25 lakh in a financial year if you switch after one year. Apart from this, you have to pay securities transaction tax (STT) at 0.001% on the redemption value of the equity-oriented fund.

Debt Funds: A type of fund which primarily invests in debt and money market instruments. Short-term capital gains tax will be levied per your income tax slab if you switch from a debt fund before three years. You have to pay long-term capital gains tax at 20% with an indexation benefit if you are switching after three years, which balances the cost of acquisition of the fund units as per the inflation rate.

Hybrid Funds: Here, these funds invest in equity and debt instruments. In this case, the tax charged to hybrid funds depends on the equity and debt allocation. If the fund invests more in equity, they are taxed like an equity fund, and if it invests more in debt and money market instruments, it gets taxed as a debt fund.

Conclusion

Switching mutual funds can benefit investors if done for the right reasons and at the right time. Factors like exit load, capital gains tax, and new suitable funds play significant roles in investment choices. An investor needs to understand the process of switching and its effects, which can help optimise the investment returns and assist in achieving financial goals. Overall, next time, if you consider switching between mutual funds, take the time to determine these factors carefully.

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