Is Tax Applicable On Inherited Mutual Funds?

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  • 03 Feb 2023

Though the transfer of a mutual fund is tax-free, the income generated it thereafter does incur tax. Find out more about it.

Inheriting a mutual fund (MF) is akin to inheriting property. An MF is passed from one person to another if:

You are the nominee of the MF investor. You will own the MF only after the investor’s death.

You are an heir to the investor who purchased the MF. In this case as well, you inherit the units once the rightful investor dies.

The MF is transferred at a rate prevailing on that day. The units are evaluated at the net asset value (NAV) available on the day the investor expires. Factors such as the time and mode of purchase, the tenure up to which the units were held by the investor, whether the units were bought directly or as a reinvestment of the stipend generated from it, do not come into play. You are not required to pay any tax for inheriting the units at the existing NAV.

Read more: Taxes on mutual funds

MFs have their own niggles though. Once an MF is passed on to you, the income generated thereafter from those units is taxable. You will be taxed in accordance with the income tax slab under which your earnings from the mutual fund fall. However, you will need to keep certain information handy:

  • In case you are planning to put your inherited mutual fund on sale, consider the original date of purchase and the original price. It will help you to evaluate your overall gain from the units. This, along with the holding tenure, will decide the tax you are required to pay on the earnings of such a mutual fund.
  • If you choose to retain the inherited mutual fund, keep in mind the following:
    • Type of mutual fund
    • Holding tenure
    • Income generated from the mutual fund

Your annual income from the mutual fund will be taxed as per the income tax slab for which your income is eligible.

Read more: Capital gains and taxability

As you pay taxes on the earnings from the inherited mutual fund, you are also eligible for certain tax exemptions on these. If your inherited mutual fund comes under the equity-linked savings scheme (ELSS), you could save on income tax. ELSS is a tax-efficient scheme, wherein the principal, dividends, and maturity amount are tax-free. Even if the inherited mutual funds are not categorised under ELSS, use the systematic withdrawal plan (SWP) and transfer your funds under ELSS. Make sure your inherited mutual funds earn you the best possible returns, depending on the amount of risk you are willing to take.

Selecting the right MF needs thorough market research. You cannot blindly settle on a random MF. Several factors come into consideration while choosing the MF that best suits your requirements. If you keep in mind the following criteria, selecting the right MF scheme is not that difficult:

Identify your goal and assess your risk-taking appetite

Identifying your goal is very important while choosing the type of MF. Are you looking for security for your post-retirement days? In that case, your objective would be long-term capital gain. Or are you planning to purchase an MF in order to pay off your ward’s college fees? If so, you are probably looking for a short-term investment. Your risk tolerance and the tenure of investment also act as deciding factors.

Know the charges and fees you are willing to shell out

If you are planning to purchase an MF, be ready to pay a certain amount of fees to the MF companies. A few of the funds have a ‘load fee’ associated with it. A ‘front-end load fee’ (paid while purchasing the units) and a ‘back-end load fee’ (charged while selling the shares before a stipulated time period) may amount to 3–6% of your total cost. Sometimes this may go up to 8.5% as well. These are charged to discourage rampant selling of shares. Some of the funds have ‘no-load fee’ options. However, other charges such as ‘expense fee’ or ‘administrative fee’, which are quite high, are tailed along with it. Evaluate the fees before jumping into any decision.

Consider the records of the fund managers and past evidence

Your fund manager’s performance goes a long way in generating profits out of your MFs. Though past evidence can be misleading at times, it is important to evaluate how a particular MF fared earlier.

Choose equity schemes if the following are your priorities:

  • an appetite for high risk
  • long-term goals
  • an investment horizon of five years and more

Once you are sure you want to invest in an equity-based MF, evaluate your risk-taking capacity. Help yourself by asking yourself the following questions:

  • Are you a conservative investor? If so, then equity-oriented balanced schemes or large-cap MF schemes would be good for you.
  • Are you a moderate investor? In that case, invest in a large-cap or multi-cap (both known as diversified equity) schemes.
  • Are you an aggressive investor? If so, mid-cap, small-cap, or sectoral schemes (only if the whereabouts of the sectors are known to you) would suit you best.

Your profile may also comprise a mix of several MF schemes. However, your decision should be based on your risk-taking appetite.

Be careful not to include the following if you have a lower risk-taking appetite:

  • Including all the top schemes from all the categories
  • If you are a first-timer, stop looking for ‘jackpots’
  • Diversified schemes, which often lead to confusion

Choosing the right MF, after all, is not rocket science if these issues are taken care of.

To Sum it up

Now that you know inheriting MFs does not incur income tax, think about generating profits out of your MF. Consider your risk-taking capacity, the tenure, and your objective. Select a scheme that fits your requirements to reap the maximum benefit.

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