Is SIP tax free? Find out if SIP is taxable or not

A Systematic Investment Plan (SIP) is a popular investment method that allows you to invest a fixed amount regularly, say monthly or quarterly, in a mutual fund scheme. However, you may wonder if there are any tax implications on SIP investments.
While SIPs themselves are not taxable, investments under most mutual funds are subject to capital gains tax or income tax at the time of redemption. However, one scheme category – Equity Linked Savings Scheme – is eligible for tax deductions under Section 80C of the old regime of the Income Tax Act, 1961.
This article tells you all you need to know about SIP taxation.

Let’s take a closer look at the features of SIPs to understand the tax implications of this investment style.

• Table of contents

1. Key features of SIPs
2. Tax implications on SIPs in mutual funds
3. Tax implications on capital gains from SIPs
4. Taxation on Income Distribution cum Capital Withdrawal from SIPs
5. How to do tax efficient SIP investment?

Key features of SIPs

• Regular investment: SIP allows you to invest a predetermined amount at regular intervals, making it one of the most disciplined investment styles. Using an SIP calculator can help you visualize how your regular investments can grow over time, helping you stay committed to your financial goals.
• Rupee-cost averaging: This feature reduces the average cost of units over time, as you purchase more units when prices are low and fewer when prices are high.
• Compounding benefit: Regular investments over a long period can grow significantly due to the compounding effect.
• Flexible and convenient: SIPs are flexible; you can start, stop, or modify the amount anytime.

Read Also: Benefits of Investing in SIPs

Tax Implications on SIPs in mutual funds

A common question among investors is, “Is SIP tax-free?” The answer is not straightforward. The taxation of Systematic Investment Plan (SIP) depends on the type of mutual fund you invest in and the duration of your investment.

Here’s a breakdown of how it works for different types of funds:

Tax implications on capital gains from SIPs

• Equity-oriented funds: If the SIP is in an equity fund, the gains are subject to capital gains tax. Short-term capital gains (STCG), for investments held for less than a year, are taxed at 15%. Long-term capital gains (LTCG) over Rs. 1 lakh are taxed at 10% without indexation benefit.

• Debt funds: Capital gains from SIP investments in debt funds made after April 1, 2023 are classified as STCG for taxation purposes irrespective of the holding period. They are taxed at the investor’s applicable income tax slab. However, SIP investments in debt funds made before April 1, 2023 and held for over 3 years are deemed as LTCG. They are taxed at 20% with indexation benefit.

• Tax-saving SIPs (ELSS): Investments in Equity Linked Savings Schemes (ELSS) via SIP qualify for a deduction under Section 80C of the Income Tax Act, 1961 up to Rs. 1.5 lakh per annum. However, the LTCG tax still applies.

Read Also: Tips for Tax-Efficient Mutual Fund Investing

Taxation on Income Distribution cum Capital Withdrawal from SIPs

IDCW from units accumulated through SIPs are taxable in the hands of the unit holders. The proceeds received is clubbed with the total income of the investor and is taxed as per their income tax slab rates. Additionally, for resident investors, the mutual fund company is required to deduct a 10% TDS if the income from units of mutual fund exceeds INR 5,000 in a financial year. For non-resident investors, the TDS deducted is 20% plus applicable surcharge plus 4% cess.

How to do tax-efficient SIP investment?

To make your SIP investments tax-efficient, consider the following:

• Choose a suitable fund: Depending on your tax slab and investment horizon, choose between equity and debt funds wisely.

• Invest in ELSS: For tax-saving purposes, consider SIPs in ELSS funds. They offer the dual benefit of tax saving and potential for reasonable returns.

• Hold investments for the long term: To benefit from lower LTCG tax, hold your equity fund SIP investments for more than a year.

• Tax harvesting: This involves redeeming and reinvesting capital gains strategically to utilise the Rs. 1 lakh exemption limit for LTCG in equity funds. Additionally, you can also use mutual fund calculators to estimate the potential returns on your investment and accordingly assess your capital gains tax. For instance, if you're opting for a step-up SIP, where you increase your SIP contributions at regular intervals, you can use a step up SIP calculator to estimate the value of your potential final corpus. You can then use this information to plan a tax-efficient withdrawal strategy. Investors can use tools like SIP lumpsum calculator to help plan their investment and withdrawal strategy to optimise for tax efficiency. The calculator shows you the potential returns on your investment based on your investment amount, tenure and expected returns. You can use this information to plan a tax-efficient withdrawal strategy.

Conclusion

SIPs are not entirely tax-free, but with careful planning and strategising, investors can make their SIP investments more tax-efficient. Understanding the nature of the fund, the applicable taxes, and using strategies like tax harvesting can significantly enhance the after-tax return on your SIP investments. Using tools like a Compound Interest Calculator can help estimate the future growth of your investments, making it easier to plan for long-term goals while considering the tax implications.

FAQs:

How to invest in SIP for tax-free returns?

While SIPs are not entirely tax-free, investing in ELSS via SIP can provide tax benefits under Section 80C. However, LTCG tax still applies. You can use a SIP calculator to estimate the return potential on your investment.

Are there any tax-free SIP options?

No SIP offers completely tax-free returns. The tax liability depends on the type of fund and the duration of the investment.

Can I claim tax benefits on all SIP investments?

Tax benefits can be claimed only on investments in ELSS SIPs under Section 80C of the Income Tax Act, 1961.

Is tax-free SIP good?

The answer depends on what your investment goal and purpose is. SIPs in ELSS schemes are eligible for tax benefits, but the scheme has a three-year lock-in period. So, it may be suitable for someone with a longer investment horizon who is seeking tax benefits. Someone who needs a more liquid investment avenue and more access to funds may not find such an investment suitable.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This document should not be treated as an endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purposes only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals, and horizon. This information is subject to change without any prior notice.