Now Reading: Switching to direct mutual funds: know the hidden tax cost
-
01
Switching to direct mutual funds: know the hidden tax cost
Switching from a regular to a direct mutual fund plan is treated as redemption of the existing units and a fresh investment, making any capital gains taxable in the year of the switch, says Mukesh Kumawat of Anand Rathi Wealth. Direct and regular plans have separate ISINs and are treated as distinct investments for tax purposes.
An investor with Rs 1 lakh in a regular plan over two years at 10% pre-expense return would face roughly Rs 2,350 in long-term capital gains tax if the Rs 1.25 lakh annual exemption is already exhausted. The breakeven period for the switch to pay off is about 4 to 5 years, after which the lower expense ratio of the direct plan begins to deliver higher returns.
Investors should check the fund's performance, whether their distributor adds value, and the applicable tax before switching. If the remaining investment horizon exceeds the breakeven period, the move may be financially beneficial.
Indian Opinion Analysis
The key calculation most investors miss is the breakeven period. In the example given, it takes nearly five years for the direct plan to recover the tax paid at switching. For someone nearing retirement or with a short horizon, the tax cost may wipe out the benefit of the lower expense ratio entirely. The Rs 1.25 lakh annual LTCG exemption is the other critical factor: if it is already used on other equity gains, every rupee of gain from the switch becomes taxable. Investors should also remember that switching SIPs triggers tax on each redeemed instalment under the FIFO rule, making the calculation far more complex than a lump sum switch.
Source: livemint.com
This story was synthesised by AI from the source linked above. Methodology and corrections.
