By: Eric Bank, MBA, MS Finance | Reviewed by: Ashley Donohoe, MBA | Updated March 06, 2019
Shares of mutual funds represent ownership of an underlying pool of stocks, bonds or other securities. A mutual fund company issues shares to and redeems (or repurchases) shares from investors. To withdraw money from a mutual fund, you start by selling shares, which might trigger capital gains taxes and possibly sales charges.
Taking money out of a mutual fund can lead to sales charges, capital gains taxes on profits and possibly IRS penalties for early IRA withdrawals.
Back-End Sales Charges
No-load mutual funds have no sales charges, but many funds charge front-end fees, back-end fees or both. Front-end charges occur at the time of share purchase, whereas back-end charges are triggered by sales. Sales charges can be as high as 8.5 percent by law, though most range from 3 to 6 percent.
Sales charges are collected by brokers who help market the mutual fund shares. Some mutual funds offer back-end fees that decline over time, encouraging investors to hold shares for the long term.
Sales Create Tax Events
Selling mutual fund shares triggers a tax-event that you would have avoided if you hadn’t sold the shares. The tax event is based on the profit or loss resulting from the share sale. A profit is measured as the excess of the sale proceeds minus the purchase cost, after adjusting for commissions and fees. Profits are taxed at capital gains rates.
Capital Gains Require Separate Treatment
Capital gains result from the profitable sale of property, including financial securities such as mutual fund shares. Long-term capital gains are profits from the sale of property held for more than one year, and they are taxed at a favorable rate. The three long-term capital gain rates are 0, 15 and 20 percent as of 2019, depending upon your total taxable income.
Short-term capital gains, for shares held for a year or less, are taxed at the same rates as ordinary income. Those rates as of 2019 are divided into seven brackets from 10 to 37 percent. You must separate capital gains from ordinary income on your tax return.
IRA Mutual Fund Penalties
If your IRA is invested in one or more mutual funds, withdrawing money from the IRA can not only trigger back-end sales charges, but also taxes and an early-withdrawal penalty. Withdrawals from a traditional IRA are always taxed as ordinary income, never as capital gains. Furthermore, if you are younger than 59 ½, you might be assessed a 10 percent early withdrawal penalty unless you qualify for an exception.
In the worst-case scenario, you might be hit by an 8.5 percent back-end charge, a 10 percent penalty and a 37 percent tax bill. In other words, you might keep less than half of the gross sale amount.
FAQs
You can generally withdraw money from a mutual fund at any time without penalty. However, if the mutual fund is held in a tax-advantaged account like an IRA, you may face early withdrawal penalties, depending on the type of account and your age at the time.
How much tax will I pay if I cash out my mutual funds? ›
If you receive a distribution from a fund that results from the sale of a security the fund held for only six months, that distribution is taxed at your ordinary-income tax rate. If the fund held the security for several years, however, then those funds are subject to the capital gains tax instead.
Is there a fee for taking money out of a mutual fund? ›
Some funds charge a fee for withdrawing money from a mutual fund account within a set number of days after making a purchase. These fees are usually used to discourage shareholders from making too many "round trips" (purchases followed by a redemption) in a short period of time.
What happens if I withdraw money from mutual fund anytime? ›
If you redeem your equity funds within one year of investment, you must pay short-term capital gains tax at 15%. If you redeem after one year, you must pay long-term capital gains tax at 10% on the gains exceeding Rs. 1 lakh in a financial year.
Can you pull out of a mutual fund at any time? ›
Mutual funds are liquid assets, and as long as you invest in open-end schemes, be they equity or debt, it's easy to withdraw your investments at any time. Moreover, there are no restrictions.
How do I avoid paying taxes on mutual funds? ›
6 quick tips to minimize the tax on mutual funds
- Wait as long as you can to sell. ...
- Buy mutual fund shares through your traditional IRA or Roth IRA. ...
- Buy mutual fund shares through your 401(k) account. ...
- Know what kinds of investments the fund makes. ...
- Use tax-loss harvesting. ...
- See a tax professional.
So all you need to do is stay invested in a Debt Fund for 3 years or longer and the indexation benefit will be applicable to your redemptions. In the case of Equity Mutual funds, long-term capital gains (LTCG) are taxable only if your returns in a financial year exceed Rs. 1 lakh.
How long do you have to hold a mutual fund? ›
You should plan to hold your mutual funds for at least 5 years. In the short term stock and bond fund prices can be volatile. Yet, over the long term their prices typically go up. The instruments can deliver more stable returns if you increase the holding duration to 10 years or more.
How do I get out of mutual funds? ›
4 steps to selling a mutual fund
- Contact your financial advisor or mutual fund company. Get in touch with the advisor who sold you the fund, or someone in their company. ...
- Ask about any fees or charges. ...
- Decide how many units or shares you want to sell. ...
- Give instructions on what to do with the money.
Cut-off time for mutual fund transactions
| Type of schemes | Cut-off time in IST |
|---|
| Liquid Funds and Overnight Funds (Subscription incl. switch-ins) | 1:30 PM |
| Liquid Funds and Overnight Funds (Redemption incl. switch-outs) | 3:00 PM |
| All other schemes (Subscription incl. switch-ins) | 3:00 PM |
1 more rowIf you have invested money through a distributor, you can place a request with him or her for the redemption of units. Following that, your distributor will send the request to the AMC office or RTA. Once the process is completed, the money will be sent to your bank account.
Is it right time to exit from mutual funds? ›
When it comes to equity, it is very important that, especially when you are thinking about long-term goals, you want to exit as soon as you have 2-3 years left approaching your goal and there are just 2-3 years to get there.
At what age can you withdraw from a mutual fund without penalty? ›
Penalties may apply. If you're under age 59-1/2 when you cash out, you may have to pay a 10% early withdrawal penalty on the taxable portion of your distribution. The penalty does not apply if you separate from service and will be at least age 55 in the year of separation, however taxes will still apply.
What is the 8 4 3 rule in mutual fund? ›
What is the 8-4-3 rule of compounding? In the 8-4-3 strategy, the average return of a particular investment amount for 8 years is 12 per cent/annum, while after that time period, it will take only half of that horizon, i.e., 4 years (total 12 years), to get a return of 12 per cent.
Are mutual funds taxed twice? ›
Mutual funds are not taxed twice. However, some investors may mistakenly pay taxes twice on some distributions. For example, if a mutual fund reinvests dividends into the fund, an investor still needs to pay taxes on those dividends.
Are mutual funds taxed as income or capital gains? ›
Capital gains distributions are paid by mutual funds from their net realized long-term capital gains and are taxed as long-term capital gains regardless of how long you have owned the shares in the mutual fund. Mutual funds may keep some of their long-term capital gains and pay taxes on those undistributed amounts.
How is mutual fund tax calculated? ›
The income in the form of dividends from mutual funds (now called IDCW) will be taxed as 'Income from Other Sources' as per your income tax slab rate. If the dividend amount is above Rs 5,000 dividend will be subject to TDS as per Section 194K @10% for resident individuals, but if the PAN is not provided then @20%.
