How are Index Funds Taxed?

Index funds are a type of mutual funds where the portfolio is made up of securities that are included  in the benchmark index. For example, an index fund that  replicates the Nifty 50 will comprise of stocks from the Nifty 50 index. 

It is a passive style of fund management and hopes to replicate  the performance of the benchmark index. Index funds are also taxed like other mutual funds. 

How are index funds taxed?

Taxes on index funds are levied both on capital gains and dividends. The dividends are calculated along with the taxable income of the investor and the entire income is taxed at  the rates decided for that category. 

Capital gains, on the other hand, are taxed separately. The length  of time the fund is held is taken into consideration. Tax is only payable  when the units are redeemed. 

For a short term holding period of twelve months or less, a tax rate of 15% is charged. However, for a long-term holding of more than twelve months, a tax rate of 10% is charged if the gains exceed  ₹1,00,000. This  includes direct equity and equity mutual funds. Cess of 4% is additionally levied on  both the taxes. 

How do index funds help minimise taxes?

1. People often choose index funds for long-term investing, which means that there is less buying and selling, which results in less payable gains, and hence are often exempt  from the more expensive  short-term capital gains tax.
2. Index funds hold a large  number of securities. The  fund manager can choose  to sell those  with the lowest  tax slab.
3. Most index funds pay  lower dividends than actively managed funds, which in turn contributes less  to an investor’s  total income and automatically reduces tax liabilities.

Index funds are considered effective as they offer reasonably  predictable returns as well as tax benefits . 

We hope you found this article  informative. If you would like  to learn more about mutual funds, browse our blog or leave a comment telling us  what you would like to learn.