Is SIP Tax-Free? Navigating the Taxation Maze of Systematic Investment Plans

The investors with tax-saving in mind should note that all SIPs are not tax-free. Explore SIP investment in mutual funds is tax free or not in this blog.
Is SIP Tax-Free?
4 mins
26-April-2024

Investing in Systematic Investment Plans (SIPs) is a popular avenue for long-term wealth creation. While SIPs offer benefits like rupee-cost averaging and disciplined investing, understanding is SIP tax free or taxable is crucial. Let’s explore the applicable tax rules and exemptions on SIPs. By grasping the tax implications associated with SIPs, investors can make informed decisions and optimise their investment strategy for better financial outcomes.

Is SIP Tax-free?

The tax treatment of SIPs depends on factors like the type of mutual fund scheme and the holding period. Capital gains from SIPs may be subject to taxes, and it's essential to understand the distinctions between short-term and long-term gains.

What are SIPs?

Systematic Investment Plans (SIPs) are a popular investment choice offered by mutual fund companies. They enable investors to regularly invest a fixed amount in a mutual fund scheme, providing the advantage of rupee-cost averaging and helping mitigate market volatility.

How Does SIP Work?

SIPs allow investors to purchase a fixed number of mutual fund units at regular intervals. Understanding this process is crucial to comprehend how capital gains are calculated and taxed.

Taxation of Capital Gains from SIPs

Taxation of gains from SIPs varies based on the mutual fund type and investment duration. The period of holding in case of SIP shall be calculated from each instalment of the SIP. For instance, if an investment in an equity fund through SIP is redeemed after 13 months from the date of SIP registration, initial SIP units held for over a year are considered long-term. Long-term gains up to Rs. 1 lakh are tax-free. The balance units shall be considered as short term as the units were held for less than a year on the date of redemption. Short-term gains from SIPs redeemed within a year are taxed at a 15% flat rate, with additional cess and surcharge.

Another instance of SIPs invested in debt funds involves the tax implications associated with them. In this scenario, if an investor chooses to invest in debt mutual funds through SIPs, the tax treatment differs based on the holding period of the investment.

If the debt mutual fund units acquired through SIPs are held for less than three years, any gains realised upon redemption are treated as short-term capital gains. These gains are added to the investor's total income and taxed according to their applicable income tax slab rates. However, if the units acquired through SIPs are held for more than three years, the gains are classified as long-term capital gains. For debt funds, long-term capital gains are taxed at a flat rate of 20% with indexation benefits. Indexation allows investors to adjust the purchase price of their investment for inflation, reducing the taxable gains and thereby lowering the tax liability.

Tax Treatment of Income Distribution cum Capital Withdrawal (IDCW) from SIPs

Income Distribution cum Capital Withdrawal (IDCW) is part of the taxable income and is taxed according to the investor's applicable income tax slab rates.

Tax Planning Strategies with SIPs

Tax-saving strategies with SIPs involve several key approaches that investors can leverage to optimise their tax benefits and investment outcomes. One effective method is to consider SIPs classified under Equity-Linked Savings Schemes (ELSS),  which offer tax exemptions under section 80C of the Indian Income Tax Act, 1961. These SIPs not only help investors save on taxes but also provide opportunities for long-term wealth creation. Additionally, SIPs offer flexibility in contributions, allowing investors to adjust their investment amounts periodically based on their financial situation and goals. This flexibility fosters financial discipline while potentially generating higher returns over the long term, all while facilitating efficient tax deductions. Moreover, early tax planning is crucial for maximising tax savings. By initiating SIP investments early in the fiscal year, investors can build a substantial corpus, leading to greater tax savings, wealth accumulation, and enhanced returns potential on their investments. Therefore, incorporating SIPs into one's investment strategy can be a prudent approach for achieving both tax-saving objectives and long-term financial goals.

When is the right time to start investing in a SIP?

The best time to start a Systematic Investment Plan (SIP) is often said to be "as soon as possible" and there's truth to that. SIPs benefit from rupee-cost averaging, which means you purchase units at various price points over time. This helps balance the impact of market volatility.

Here are some ideal times to consider starting an SIP:

  • Early in your career: The power of compounding works best when you start early. Even small contributions can add up significantly over time.
  • When you have a stable income: SIPs require consistent investment, so a steady income stream is crucial.

You don't necessarily need to wait for a market correction to begin an SIP. SIPs are designed for the long term, and market fluctuations tend to even out over time.

Conclusion

Incorporating SIPs into financial strategies, especially in ELSS, can enhance returns and offer tax savings. With flexibility, potential for early tax planning, and a disciplined approach to wealth creation, SIPs play a crucial role in an investor's journey. Understanding the tax implications is paramount, and seeking professional advice ensures optimised investment decisions.

You can start an SIP with as low as Rs. 100 on the Bajaj Finserv Platform, invest now!

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Frequently asked questions

Which SIP is tax-free under 80C?

The SIP itself isn't tax-free, but investments in Equity Linked Saving Scheme (ELSS) mutual funds qualify for tax deductions under Section 80C of the Income Tax Act. You can claim deductions up to Rs. 1.5 lakh annually.

Is SBI SIP tax-free?

It depends on the mutual fund scheme underlying the SBI SIP. Only ELSS SIPs within SBI's offerings qualify for tax deductions under Section 80C.

How much tax will I pay on SIPs on ELSS mutual funds?

ELSS funds are special because they offer tax benefits while you invest (Section 80C deduction) and lower taxes on long-term gains (held over 1 year). However, there's a lock-in period of 3 years for your money. Each SIP installment you make throughout the year (April to March) qualifies for the tax deduction for that year. But each SIP installment also has its own 3-year lock-in period, starting from the investment date.

For example:

  • An SIP started in April 2017 qualifies for tax deduction in the financial year 2017-18. But this specific SIP installment is locked until April 2020 (3 years from its start).
  • Similarly, an SIP started in June 2018 qualifies for tax deduction in the financial year 2018-19, but is locked until May 2021 (3 years from its start).

 

While all your SIPs throughout the year get the tax benefit, each one has a separate lock-in period starting from its investment date.

Which mutual fund is tax-free?

No mutual fund is entirely tax-free. However, ELSS mutual funds offer tax benefits on investment (Section 80C deduction) and long-term capital gains (after one year).

How can I save tax on my SIP return?

Invest in ELSS SIPs to claim deductions under Section 80C. Hold your equity funds for over a year to benefit from lower long-term capital gains tax.

Is tax automatically deducted from mutual funds?

No, tax isn't automatically deducted from mutual funds. You are responsible for paying capital gains tax when you redeem your units. However, TDS (Tax Deducted at Source) applies to dividend income from debt funds.

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