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?
6. Tax Benefits of SIP Investments
7. Tax Planning Strategies with SIPs

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.

Tax Benefits of SIP Investments

Efficient tax planning plays a critical role in minimising tax liabilities and maximising income. An effective tax-saving option is investing in Equity Linked Saving Schemes (ELSS), which offer SIP tax saving benefits under section 80C of the Income Tax Act. ELSS funds have a mandatory lock-in period of 3 years. By opting for an SIP in an ELSS fund, individuals can claim a deduction of up to Rs. 1.5 lakh per year.

One of the notable advantages of ELSS funds is their relatively short lock-in period compared to other tax-saving options under section 80C of the Income Tax Act, 1961.

Tax Planning Strategies with SIPs

Modern investors are increasingly turning to Systematic Investment Plans (SIPs) as a long term -return investment option. Here are some ways in which SIPs can contribute to tax savings. The same strategies are true for lumpsum investment as well:

• Reducing tax obligations - SIPs that fall under the category of Equity-Linked Savings Schemes (ELSS) and are eligible for tax exemption under section 80C of the Indian Income Tax Act, 1961.
• Enhanced flexibility - SIPs provide flexibility and investors can tweak their monthly/quarterly amount based on their changing financial situation. This not only fosters financial discipline but also generates higher returns over long term while facilitating efficient tax deductions.
• Early tax planning -Tax planning at the beginning of the year is the ideal approach to maximise tax savings. By initiating early investments in a Systematic Investment Plan, investors can build a substantial corpus, leading to greater tax savings, wealth creation, and higher returns potential on the investments. Investors can also use an SIP calculator online to help determine how much they should invest monthly in an ELSS fund to reach their tax exemption limit. An SIP calculator step up can help you plan increasing your SIP amount gradually by helping you understand the impact on the returns.

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.

Which SIP is tax-free under 80C?

Equity-Linked Saving Schemes (ELSS) are the only SIPs that offer tax benefits under Section 80C of the Income Tax Act, allowing you to claim a deduction of up to Rs. 1.5 lakh per financial year. This helps reduce taxable income, resulting in significant tax savings. ELSS funds have a 3-year lock-in period and are equity-oriented, meaning they come with market risks. It's always advisable to consult a financial advisor before making investment decisions.

How to calculate tax on SIP returns?

To calculate tax on SIP returns, the tax implications depend on the type of mutual fund and the holding period:

Equity-Oriented Funds (including ELSS): Short-Term Capital Gains (STCG) tax is 20% if redeemed within a year. Long-Term Capital Gains (LTCG) tax is 12.5% on gains over Rs. 1.25 lakh if held for more than a year.

Debt-Oriented Funds: Taxed as per your income tax slab.

To calculate tax:

1. Determine the Cost Basis using FIFO or Average Cost Method.
2. Calculate Capital Gains by subtracting the cost basis from the selling price.
3. Apply Tax Rates based on the holding period.

Using online tools can help estimate your tax liability, but it’s advised to consult a tax professional for precise calculations and guidance.

How much SIP is tax-free?

There is no entirely "tax-free" SIP, but you can reduce tax liability by investing in Equity-Linked Saving Schemes (ELSS) through SIPs. ELSS SIPs offer tax benefits under Section 80C, allowing you to claim a deduction of up to Rs. 1.5 lakh per year, though they carry market risk due to their equity nature. Other mutual funds, such as non-ELSS equity funds and debt funds, are subject to tax based on capital gains and the holding period.

How to avoid tax on SIP?

While you can't completely avoid taxes on SIPs, you can significantly minimize them by making strategic investments. To minimize taxes on SIPs, invest in tax-saving ELSS funds under Section 80C for potential deductions and long-term growth. Timing your withdrawals, diversifying between equity and debt funds, and using SWPs can help optimize tax liabilities. Staying informed about tax laws and consulting a financial advisor ensures effective tax planning.

Which investment is 100% tax-free?

While there isn't a single investment that is 100% tax-free in all aspects, several investment options offer significant tax benefits:

PPF and EPF offer tax-free interest and maturity amounts, with contributions deductible under Section 80C.

NPS allows tax deductions under Sections 80C and 80CCD(1B) and offers partial tax-free withdrawals.

Life insurance policies and SSY provide tax-free maturity amounts, with contributions eligible for Section 80C deductions.

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

ELSS allows you to claim a deduction of up to Rs. 1.5 lakh under Section 80C. After the mandatory 3-year lock-in period, LTCG on ELSS is tax-free up to Rs 1 lakh. Stay updated on tax laws and consult a financial advisor for effective planning.

How can I save tax on my SIP return?

Time your withdrawals strategically by holding investments long-term and using tax-loss harvesting. Diversify your portfolio, consider SWPs for regular income, and stay updated on tax laws, seeking professional advice to optimize your tax strategy.

How much tax on SIP after 20 years?

If you hold your SIP investments for 20 years, they will be considered long-term capital gains. The tax on returns depends on the type of fund:

• Equity-Oriented Funds (including ELSS): Rs. 1.25 lakh of long-term capital gains (LTCG) is tax-free, with gains exceeding Rs. 1.25 lakh taxed at 12.5% without indexation.
• Debt-Oriented Funds: Taxed as per income tax slab.

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.