Mutual funds have emerged as one of the most preferred investment vehicles for Indian investors. They offer diversification, professional fund management, and the potential for attractive returns. But as with any investment, profits from mutual funds are subject to taxation. Fortunately, with proper planning, you can significantly reduce or even eliminate the taxes you pay on your mutual fund gains.
This blog will walk you through the various tax-saving strategies available on mutual fund investments in India.
Taxation of Mutual Fund Gains: A Quick Overview
To save tax, it’s important to understand save tax on mutual fund gains. Mutual fund gains are categorized based on the type of fund and the duration of holding.
1. Equity Mutual Funds:
These funds invest at least 65% of their portfolio in equities.
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Short-Term Capital Gains (STCG): Gains on investments held for less than 12 months are taxed at 15%.
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Long-Term Capital Gains (LTCG): Gains from units held for over 12 months are tax-free up to ₹1 lakh in a financial year. Gains above that are taxed at 10% without indexation.
2. Debt Mutual Funds:
These invest in debt instruments like bonds, treasury bills, etc.
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For units bought before April 1, 2023, LTCG after 3 years is taxed at 20% with indexation.
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For units bought on or after April 1, 2023, gains—regardless of holding period—are taxed as per your income tax slab.
Understanding Taxation on Mutual Fund Gains
Before jumping into tax-saving strategies, it’s important to understand how mutual fund gains are taxed in India. Mutual funds are primarily classified into two categories for tax purposes:
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Equity Mutual Funds – Funds that invest at least 65% in equities.
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Debt Mutual Funds – Funds that invest primarily in debt instruments like bonds and fixed-income securities.
Capital Gains Tax on Equity Mutual Funds:
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Short-Term Capital Gains (STCG): If you sell equity mutual fund units within 12 months, you will be taxed at 15%.
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Long-Term Capital Gains (LTCG): If you sell after 12 months, gains over ₹1 lakh in a financial year are taxed at 10% without indexation.
Capital Gains Tax on Debt Mutual Funds:
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Short-Term Capital Gains: If sold within 36 months, gains are added to your income and taxed as per your slab.
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Long-Term Capital Gains: If sold after 36 months, they are taxed at 20% with indexation benefits (only available for units bought before April 1, 2023, due to tax rule changes).
Top Strategies to Save Tax on Mutual Fund Gains
Let’s now look at proven ways to legally reduce your tax burden:
1. Harvest Long-Term Gains Annually
For equity funds, you can redeem units each financial year and book gains of up to ₹1 lakh—completely tax-free. This strategy, called LTCG harvesting, lets you reset the cost of acquisition and reduce future tax liability while keeping your funds invested.
Example: Suppose your investment grows by ₹1.5 lakh. You can redeem units worth ₹1 lakh of gain in the current year (tax-free) and redeem the rest next year—again potentially tax-free if gains remain under ₹1 lakh.
2. Invest in ELSS for Dual Benefits
Equity Linked Savings Schemes (ELSS) are a great way to save tax under Section 80C of the Income Tax Act. You can invest up to ₹1.5 lakh in ELSS each year and claim deductions, reducing your taxable income.
What’s more? The returns from ELSS are taxed like any other equity fund, which means you still get the ₹1 lakh LTCG exemption.
3. Use Systematic Transfer and Withdrawal Plans
If you’ve invested a lump sum in a debt fund or liquid fund, you can gradually transfer money into an equity fund using a Systematic Transfer Plan (STP). Similarly, you can redeem investments through a Systematic Withdrawal Plan (SWP), spreading your capital gains across multiple financial years and staying within lower tax slabs.
This approach is particularly useful for retirees who want regular income but wish to minimize tax impact.
4. Choose the Growth Option Wisely
Mutual funds offer two major options—dividend and growth. Earlier, dividends were tax-free in the hands of investors. But now, all dividends are added to your income and taxed according to your slab.
The growth option, however, allows your investments to compound over time. Taxes are only paid on capital gains when you redeem the units, making this a more tax-efficient choice for long-term investors.
5. Redeem in Lower Income Years
If you anticipate a year where your taxable income will be lower—say due to a break in employment, a sabbatical, or post-retirement—you can plan to redeem your mutual fund investments in that year. Since your income will be in a lower tax slab, your STCG on debt funds and dividends may be taxed at a much lower rate.
6. Time Your Redemption Wisely
You can also save tax by holding your investment for a longer period to convert short-term gains into long-term ones.
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In equity funds, wait at least 12 months before redeeming to enjoy LTCG benefits.
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For debt funds purchased before April 1, 2023, hold for more than 3 years to get the indexation benefit.
Final Words
Saving tax on mutual fund gains is not about using shortcuts—it’s about strategic planning. The Indian tax system offers several legitimate opportunities to minimize your tax outgo, and investors should take full advantage of them. Whether it’s through ELSS investments, systematic withdrawals, or timing your redemptions, a little planning can go a long way.
If you’re unsure about the best tax-saving approach for your mutual fund investments, consult a certified financial planner or tax expert. With the right strategy in place, you can not only grow your wealth but also keep more of it in your pocket.
