Zero Tax on SIP Withdrawal: Investing in Mutual Funds through Systematic Investment Plans (SIPs) has become a household habit for many. While we diligently plan our investments, we often overlook the tax implications during withdrawal. Many assume that tax calculations are solely the job of a Chartered Accountant (CA). However, tax planning must begin before you hit the redeem button. With a smart strategy, you can legally reduce your tax liability on SIP gains to zero.
Understanding the Withdrawal Rule (FIFO)
When you invest via SIP, units are allotted based on the Net Asset Value (NAV) of that specific day. Since the market fluctuates, every installment buys units at a different price. When you decide to withdraw money, the ‘First In, First Out’ (FIFO) rule applies. This means the units you purchased first (the oldest ones) are sold first. The tax rate is determined by how long you have held these specific units.
Short-Term vs. Long-Term Capital Gains
Taxation on Equity Mutual Funds depends entirely on the holding period:
- Short Term Capital Gain (STCG): If you sell units within 1 year (365 days) of purchase, the profit is taxed at 20%. There is no exemption limit for this.
- Long Term Capital Gain (LTCG): If units are sold after holding them for more than 1 year, the profit is taxed at 12.5%.
- The Exemption Limit: The government provides a tax exemption on Long Term Capital Gains up to ₹1.25 Lakh per financial year. You only pay tax if your profit exceeds this amount in a single year.
The Smart Strategy for 0% Tax
Suppose your portfolio has grown significantly, and you need to withdraw a lump sum amount, say ₹9 Lakhs. If you withdraw the entire amount in one go, your long-term profit might exceed ₹1.25 Lakhs, forcing you to pay 12.5% tax on the excess amount. Here is how you can avoid it:
- Leverage the Financial Year: In India, the financial year runs from April 1st to March 31st.
- Split Your Withdrawal: Instead of redeeming the full amount at once, split it into two parts. Withdraw half the amount before March 31st and the remaining half after April 1st.
- The Benefit: By doing this, you utilize the ₹1.25 Lakh tax exemption limit for two separate financial years. This allows you to book up to ₹2.50 Lakhs of profit tax-free, potentially bringing your tax liability down to zero.
Before redeeming your mutual funds, a simple calculation regarding your holding period and the financial year can save you a significant amount of money legally.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Please consult your financial advisor before making investment decisions.
