Debt mutual funds are funds that invest in fixed-income assets. These are open-ended funds that present a relatively low risk. As a result, they are often used for short-term goals and as diversification tools. Debt funds allow you to invest in a lump sum or through a systematic investment plan (SIP).
Debt funds can offer plenty of benefits to investors. One of these is the indexation benefit. Let’s find out more about the same to make a more informed investment decision.
What is the indexation benefit?
Indexation benefit regulates the purchase price of your investment according to the change in the inflation rate from the time you invest your money to when you redeem it. As you may know, inflation is constantly rising. As a result, it impacts your profits and the cost of investment.
Your profit after indexation can be calculated using the cost of inflation index (CII). This is fixed and released by the Central Board of Direct Taxes (CBDT) every year. Here is the formula:
Profit after indexation = cost of investment x (CII of the year of sale/CII of the year of purchase)
What is the indexation benefit on debt mutual funds?
Debt mutual funds are taxed in two ways:
Short-term capital gains (STCG):
Short-term capital gains tax is levied on mutual fund investments held for less than three years. The profits of these investments are added to your overall income for the year and taxed as per the income tax slab you fall into. There are no indexation benefits applied in the case of short-term gains.
Long-term capital gains (LTCG):
Long-term capital gains tax is levied on mutual fund investments held for three years. The profits of these investments are taxed at a flat rate of 20% with indexation.
Is it mandatory to take the indexation benefit on debt mutual funds?
If you do not want to take the indexation benefit, you will pay tax on your profits as per the income tax slab you fall into for the concerned year. However, you must know that debt funds are the only mutual funds that offer an indexation benefit. The decision to take the indexation benefit or not lies in your hands.
Another thing to keep in mind, long-term capital gains tax may be lower than short-term capital gains tax. Therefore, when you redeem your investment, make sure first to ascertain the impact of taxes and the indexation benefit on your earnings. Sometimes, it can be more beneficial to hold on to your investments for a little longer.
To sum it up
Tax can alter the course of your investment returns to a great extent. Hence, understanding how your investments are taxed is fundamentally essential. When it comes to debt mutual funds, you can enjoy many advantages along with tax benefits by investing in them. So, make sure to use them to your benefit and enhance your overall returns with the applicable tax provisions.
The Tata Capital Moneyfy App offers many debt mutual fund options. Download the app from Google Play Store or Apple Store and start a SIP in your favorite debt fund today!