Exit Load and Taxes associated with Investing in Mutual Funds


A Mutual Fund is a common ('mutual') pool of money ('fund') managed by a Fund Manager (an individual or a team). It is a great way for individual investors to get easy access to professionally managed and well-diversified portfolios of stocks (equity) and bonds (debt).

Apart from the fund management fees that the Mutual Fund charges you for managing your money on an on-going basis, there are 2 types of charges/costs that you may incur when you redeem your money.

1. Exit Load

Exit load is like a penalty for withdrawing your investments too soon. Mutual Funds usually do not have lock-ins but they do charge you for very quick withdrawal of funds. Not all funds have it but it is fairly common in equity funds. Also, the length of time considered as too-soon is generally 1 year for equity funds (there are exceptions) but varies greatly for debt funds.

  • It is only applicable when you sell your Mutual Fund units 'too soon'.

  • Equity funds: 1% of the total amount being withdrawn within 1 year of being invested is deducted. If the units are held for more than 1 year, then no exit load is applicable. This is the most general case. However there are funds with exit load extending beyond 1 year as well.

  • Debt funds: For Short Term Debt funds, it is usually nil; for Medium Term Debt funds it may be nil or have a very short applicable period e.g. a week to a month. For Long Term Debt funds it is usually 1% and the applicable period ranges from 6 months to an year.

2. Taxes!

You can run but you can't hide. Well, may be you can if you own some cool Panama hats but for the rest of us, taxes are a certainty. But there is good news. Mutual Funds are probably the most tax efficient investment options out there for both equity and debt.

The biggest component of Mutual Fund taxation is the Capital Gains Tax (the tax on profits) which is discussed below. There are some other taxes as well like STT and Dividend tax which are covered in a more detailed post here.

  • Capital Gains Taxes are applicable only when you sell and only on the gains made on the units being sold.

  • For Resident Indians, the tax is NOT deducted by the Mutual Fund. Tax is to be paid by you before the financial year ends on your own. For NRIs, the Mutual Funds will deduct the tax (TDS) from the investments when you withdraw the money.

  • Capital Gains Taxes depend not only on amount of gains but also on the type of investment (equity or debt) and the length of time the investment is held for (short term or long term). See the summary table below.

Capital-Gains-Taxation-of-Mutual-Funds-1

  • LTCG in stocks and equity Mutual Funds upto Rs. 1 lakh in a financial year will be free of tax. LTCG Tax at 10% will only apply to equity LTCG beyond Rs. 1 lakh at a PAN level for a financial year.

  • Indexation means after subtracting inflation from your overall returns i.e. if overall returns are 8% and inflation is 7% then tax applicable is 20% of (8%-7%) = 20% of 1% = 0.2%.

  • Debt Mutual Funds are 10 times more tax efficient than Fixed Deposits while providing similar safety and returns because of indexation benefits. In FD all gains are taxed at your current income tax level irrespective of how long the FD was kept for. So in this example if you are in the 30% bracket, your tax applicable would be 30% of 8% i.e. 2.4% - more than 10 times than that of debt funds!

  • [Advanced stuff] In case of losses in one investment, a tax deduction can be claimed for profits in another investment. These deductions can also be carried forward to be offset against future gains, if and when they happen. (This is an oversimplified version of taxation of losses - you can ignore it for now, you will know when you need it).

Whenever you consider selling your investments, take into account these costs or they could eat into your returns. More reasons to stay invested for the long-term. :)