What is Exit Load in Mutual Funds and How Is It Calculated

August 9, 2024 Mutual Fund

Against the backdrop of intense volatility in the Indian equity market, I wrote an article recently explaining when investors should sell their mutual fund units. I stated therein that there ought to be strong and valid reasons to sell or redeem your mutual fund units, and this decision, mustn’t be taken arbitrarily.

Selling is an important part of the investment process and, therefore, it needs to be well thought out, whereby it strategically positions your portfolio.

When you sell units of a mutual fund scheme, apart from personal factors, there are tax implications and costs involved. In this regard, you need to understand what exit load is.

If you are exiting, i.e. selling or redeeming units of a mutual fund scheme (partially or fully) within a stipulated time period from the date of investment, a fund house levies an exit load.

What Is an Exit Load?

An exit load is akin to a penalty for prematurely redeeming units of a mutual fund scheme before the stipulated time period from the date of investment. It is charged as a percentage and is applied to the NAV (Net Asset Value) applicable at the time of redemption.

So, the exit load structure has two parameters to it: 1) the stipulated time period from the date of purchase, and 2) the rate or percentage that is applied to the NAV.

The exit load varies across fund houses and schemes. It is stated in the Scheme Information Document (SID). As per the Central Board of Indirect Taxes and Customs (CBIC), a mutual fund house is liable to pay Goods & Services Tax @18% on the exit load.

How is Exit Load Calculated?

Say, the exit load of the scheme is 1% on the first 365 days (the stipulated time period) and you are redeeming 100 units at an NAV of Rs 225/-, you will be charged Rs 225 as the exit load and Rs 22,275/- will be the redemption proceed (subject to the Securities Transaction Tax, as applicable). So, remember exit load is charged on the NAV at the time of redemption.

In the case of SIPs, the calculation gets a bit complicated. On every SIP instalment that has not completed the stipulated time period, an exit load will apply whereas for the ones that complete the stipulated time period, there will be no exit load. The first-in-first-out concept applies here. Simply put, the earliest SIP instalment will be assumed to be redeemed first, and only if the stipulated time period is not completed (from the date of investment), the exit load will apply.

Why is Exit Load Charged and Can You Avoid It?

Exit load is charged to discourage you from selling the units too soon, i.e. before the stipulated time period. The rationale behind it is to protect the interest of those investors who choose to remain invested.

In the case of equity mutual funds, the exit loads are usually higher than debt funds. This is because, typically, equity funds are suited for the long-term (3 years or more). So, if you are investing for the short term, exit load would be applicable.

In the case of equity funds, if you want to avoid exit load, equity-oriented Exchange Traded Funds (ETFs) can be considered. Similarly, many index funds do charge an exit load.

Among the debt funds, liquid funds — which are to park money for the short-term (for a couple of weeks to up to 6 months or so) — SEBI has introduced the concept of graded exit load up to 6 days and no exit load from the seventh day.

In the case of overnight funds, which are even more liquid are used to deploy money for a week or do, have no exit load.

Note that exit load would be applicable if the units of mutual funds are sold within the stipulated time period irrespective of whether you are making a capital gain or a loss.

The exit load will also apply if you are switching from one scheme to another scheme of the same fund house within the stipulated time period.

Likewise, on STP (Systematic Transfer Plan) transactions, depending on the type of source scheme, exit load applies if the transfer is within the stipulated time period. This is because a switch and STP transaction are ultimately a redemption.

Even when you are opting for SWP (Systematic Withdrawal Plan), exit load will apply if the stipulated time period from the date of investment is not completed. Hence, you should plan systematic withdrawals once the stipulated time period applicable for exit load is over.

Keep in mind that, the redemption proceeds received by you are after levying the exit load, i.e. it is net of exit load. Simply put, the fund house deducts the exit load from the capital gain or loss, as the case may be. Thus, the capital gains or losses are net of exit load.

Watch Out for Capital Gain Tax When You Exit a Mutual Fund Scheme

The capital gain made when you exit a mutual fund scheme, i.e. the sale value is greater than the cost of purchase/acquisition, you the investor or assessee will be liable to pay Short Term Capital Gain Tax (STCG) or Long Term Capital Gain (LTCG) tax, as the case may be.

With effect from July 23, 2024, the Modi 3.0 government vide the Finance Bill 2024 has increased both STCG and LTCG Tax.

In the case of equity mutual funds, STCG (holding period of less than 12 months) will now be taxed at 20%, whereas LTCG (holding period of 12 months or more) will be taxed at a flat 12.5%, provided the gains are more than Rs 1.25 lakh in a financial year with effect from July 23, 2024.

In the case of debt-oriented mutual funds, irrespective of whether the STCG or LTCG will be taxed as per your income your income-tax slab, i.e. at the marginal rate of taxation.

What if there is a capital loss? You bear the loss. Note, the Long Term Capital Loss can be set off only against Long Term Capital Gains, whereas, the Short Term Capital Losses are permitted to be set off against both Long Term Capital Gains and Short Term Capital Gains.

Now, in case you have not been able to set off the capital losses in the same Assessment Year (AY), a carry forward is permitted up to 8 years for both Short Term as well as Long Term Capital Loss.

To learn more about the taxation of mutual funds, read this article: Mutual Fund Taxation After Union Budget 2024-25

In Conclusion…

Make sure are making informed decisions when selling or redeeming your mutual funds. Because, ultimately, the exit loads and taxes impact your returns. An exit load is to deter you from prematurely redeeming your investments. Thus, as far as possible, avoid exiting or redeeming from a fund prematurely unless it is absolutely necessary.

Be a thoughtful investor.

Happy Investing!

This article first appeared on PersonalFN here