A Complete Guide on Mutual Fund Switch - Rules, Benefits and Taxation (2024)

The need to switch mutual funds may arise if an investor believes that moving their money from one investing scheme to another would give them better returns. Though this strategy could work, there are certain important factors that you need to consider before switching mutual fund schemes.

In this piece, we have simplified the otherwise complexities of switching mutual fund schemes. Let’s dive in.

What is a Mutual Funds Switch?

When you switch from debt to equity funds or from regular to direct mutual fund plans in a bid to mitigate risk or generate better returns is basically termed as mutual funds switch. In simpler words, you switch mutual funds when you move from one mutual fund scheme to another.

Normally, investors switch mutual funds if they feel their existing mutual fund scheme isn’t performing as per their expectations.

You can also switch fund houses, but in this case, you would need to redeem your units from the existing fund house and buy units from the new fund house you plan to switch to. This involves exit loads and capital gain payments (more on this later).

If you’re switching within the fund house, you can either switch between asset classes – example: equity to debt schemes, or from regular to direct plans.

When Can You Switch Mutual Funds?

There could be multiple factors that may lead you to switch mutual funds. It could be because:

Your investment goals have changed
Your existing mutual fund scheme isn’t performing well
You want to move to a different asset class
You want to switch your regular plan to direct plan
You want to switch to another AMC (Asset Management Company)

However, before going for a mutual fund switch, you need to understand how to go about it and the other factors that need to be taken into account.

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Disclaimer: Mutual fund investments are subject to market risks, read all scheme-related documents carefully.

How to Switch from One Mutual Fund Scheme to Another Mutual Fund Scheme?

Investors can switch mutual funds either offline or online.

a. How to Switch Mutual Funds Online?

The steps involved in switching mutual funds online include:

Step 1: Log in to the Demat account that holds the mutual fund units in question.

Step 2: On the transaction page, one can purchase, switch or redeem funds. The next step involves choosing the switch option and the new plan.

Step 3: The fund house will receive a request for the plan change.

Step 4: If the switch request is done before 3 PM and the amount is less than Rs. 2 lakhs, investors will receive the same-day refund. Higher amounts demand more time for unit allocation. It can take at least 3 days for your funds to be transferred.Step 5: The investor should check the status of the mutual fund switch after 4 days. Online portals also allow investors to directly upload their existing portfolio and perform the switch.

b. How to Switch Mutual Funds Offline?

The steps involved in offline mutual fund switching involve:

Step 1: Visit the office of your portfolio manager or the institution dealing with mutual funds.

Step 2: Obtain a transaction switch form. Submit the form after including details of the fund name, portfolio number and the target scheme.Step 3: Wait for a confirmation mail on your registered email address from the fund house.

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Rules for Switching Mutual Funds

Before switching mutual funds in a portfolio, investors need to understand the relative income-generating capacity of the switched fund and the mutual fund switch rules. Evaluation and revaluation of the portfolio are crucial. Here are some rules you should keep in mind before going ahead with the switch:

Investors can switch their mutual fund investments within the same fund scheme or a different one. Some basic rules for switching within the same fund scheme include fulfilling the minimum investment criteria, bearing the burden of exit loads and taxes on capital gains, etc.
Inter-fund switching is possible by selling the existing fund scheme and applying for redemption. The IT Act rules that capital gains attract taxes, and those from mutual funds are subject to short and long-term taxation on capital gains. Equity funds attract 15% taxation for short-term gains and 10% for long-term gains.
Moreover, some mutual fund schemes like Equity Linked Savings Scheme have lock-in periods of 3 years. This indicates that investors cannot switch from these accounts before that.

Factors to Consider Before Switching Mutual Funds

One should consider several factors before deciding to switch mutual funds. These include:

Taxation: Switching a mutual fund involves selling it for a more profitable one. However, short-term and long-term capital gains are subject to taxation. The capital gains earned from switching mutual funds are referred to as redemption. The following table explores the tax rates investors should abide by while switching funds.

Fund Type	Term	Tax rates
Equity Fund	<1 year	15%
Equity Fund	>1 year	10%
Debt Fund	= >3 years	20%
Debt Fund	<3 years	In accordance with the tax slab rate.

Additionally, hybrid funds are also subject to taxation as per equity funds if at least 65% of the investments are equity-oriented.

Exit load: Asset management companies charge a small percentage of a fund’s Net Asset Value (NAV) on the sale and purchase of new funds. The exit load fee is deducted as a percentage of the redemption value when the investor plans to switch. However, selling funds during the lock-in periods attracts additional exit penalties.
Documentation and diligence: Mutual fund investors deal with much documentation, especially when switching funds. They should handle all KYC and offer documents efficiently. This ensures timely submissions and no penalties.

What Happens When You Switch Mutual Funds?

Switching mutual funds is a two-way process involving the sell and purchase orders. While the former is subject to taxation, the latter is proportional to its net asset value. Investors may use Compounded Annual Growth Rate (CAGR) and Extended Internal rate of return (XIRR) to predict the growth potential of a fund.

Mutual fund switch rules mention paying short-term capital gains tax and long-term capital gains tax after 1 year. However, switching from Debt funds involves paying short-term capital gains tax (less than 3 years).

All gains are generally added to the taxable income and taxed after that. Long-term capital gains (more than 3 years) attract 20% taxes.

Benefits of Switching Mutual Funds

Experts believe that mutual fund switching can improve asset allocation. Inter or Intra fund switching is considered redemption because it involves omitting the liability associated with a particular fund. Some major benefits of mutual fund switching are as below:

With mutual fund switching, one can reduce liability with an underperforming asset and shift to a higher-performing one. Investors often use parameters like CAGR and XIRR to understand the net growth rate of the asset. Long-term assets can be identified by their ability to reap maximum benefits on maturity.
Digitisation has enabled investors to perform operations like mutual fund switching easily. Not only can they apply for a switch online, but they can also directly transfer their money from one scheme to another.

Mutual Fund Switch Tax Liabilities

Tax effects on mutual funds switching are the same as in the case of withdrawal/redemption of mutual fund units. Fund houses can deduct taxes for short and long-term capital gains generated from the redemption of mutual fund units. Nevertheless, if your overall income is less than the exemption limit, TDS deductions can be avoided by submission of form 15G or 15H.

Point to note: go through the relevant tax laws before switching mutual funds. For instance, switching equity funds before one year of the investment would imply 15% taxation on capital gains. However, if you switch after one year of investment, the move is tax-free.

Final Word

Investors may choose to switch mutual funds when evaluating their asset allocations in terms of their money-making capacity. They can do it manually through physical presence or by using tools like a Systematic Transfer Plan (STP).

FAQs on Mutual Fund Switch

Q1. When is the correct time to switch a mutual fund?

Ans. Investors should have a clear idea of their investment decisions and the time period in which they wish to fulfil them. Mutual fund exit may be triggered by achievement or change in financial goals, extreme market volatility due to political factors, etc. But fund underperformance is a primary cause of mutual fund switching.

Q2. What are the documents required to invest money in a mutual fund?

Ans. Any asset management company requires potential investors to understand the terms of the scheme. Also, they need some documents containing investors’ personal information. This includes an Aadhaar card, PAN card, a savings bank account, etc.