What is mutual fund redemption and how to redeem mutual funds?

Understanding how and when to redeem investments is an essential part of financial planning for first-time Mutual Fund (MF) investors. The process of withdrawing your invested money, either partially or fully, from a mutual fund scheme by selling it back to the fund house at the current Net Asset Value (NAV) is known as mutual fund redemption. 

Investors often redeem funds invested through a lump sum or a Systematic Investment Plan (SIP) to manage financial emergencies, achieve personal financial goals, or reallocate capital to better-performing investment avenues. 

What is mutual fund redemption?

When an investor sells or withdraws their fund units to obtain returns, it is known as mutual fund redemption. Simply put, it is the act of exiting an MF scheme and redeeming the units you hold. Redeeming mutual funds provides you with an exit route from the investment and gives you the present value of the investment in terms of monetary returns.

You can either redeem units in parts or exit fully. There are 3 major types of redemption you can opt for:

• Unit-based redemption
• Amount-based redemption
• Redeem all

Additional Read - How To Invest in Index Funds in India – All You Need to Know About Index Funds

What are the types of redemption?

Here are the different types of mutual fund redemption:

1. Unit-based redemption

The investor specifies the number of units to be redeemed. The amount received is based on the current NAV of these units.

2. Amount-based redemption

The investor indicates the specific amount they wish to redeem. The mutual fund then adjusts the number of units to match this amount based on the NAV.

3. Redeem all units

The investor decides to withdraw their entire investment from the mutual fund. This method is often used when the investor wants to exit the investment altogether.

4. Systematic withdrawal plan (SWP)

The investor sets up a systematic withdrawal plan to redeem a fixed amount or a specific number of units at regular intervals, such as monthly or quarterly. This provides a steady stream of income while keeping the remaining investment growing.

Reasons for mutual fund redemption

Many factors can prompt investors to redeem their mutual funds:

1. Achieving financial goals

Investors often redeem their funds upon reaching specific financial milestones, like buying a home, funding higher education, or saving for retirement.

2. Handling financial emergencies

Unexpected situations, such as medical emergencies, job loss, or urgent large expenses, might require immediate access to funds. Redeeming mutual funds can provide a quick source of cash to manage these crises.

3. Dissatisfaction with fund performance

Continuous underperformance of a mutual fund compared to market benchmarks or other investments can lead investors to withdraw their money. They may seek better-performing alternatives to maximize their returns.

4. Market conditions and volatility

During periods of significant market volatility or economic downturns, investors might choose to redeem their mutual funds to safeguard their investments from further losses.

5. Revising investment strategy

As investment goals or risk tolerance evolve, investors might redeem their current funds to reallocate their investments.

When to redeem a fund?

Selecting the right time for mutual fund redemption is essential. It depends on your investment goals. You might have invested in an SIP for 10 to 15 years to fund your child’s education or for a short-term goal like purchasing a car. Consider redeeming the fund units once you are closer to fulfilling your financial goal.

Here are a few other valid reasons to redeem your fund units:

• Financial crisis
• When the market is high
• Change of strategy by the fund house
• When the MF scheme is underperforming

How to redeem mutual funds?

The process for redeeming mutual funds is simple. You can opt for mutual fund redemption online or offline, depending on your convenience and the type of MF you hold. It takes five days or more for the amount to reflect in your bank account, provided you have submitted the redemption request with accurate details. 

The different ways to complete mutual fund redemption online are as follows: 

• Visit the Asset Management Company’s (AMC) official website or platform. To raise the request, enter the required details, including the folio number, number of units, etc.
• Send a redemption request to a linked broker through your Trading or Demat account. 

If you wish to follow the offline route, you will need to fill out a physical redemption request form and submit it at an authorized Registrar and Transfer Agent (RTA) office like CAMS. You may also request redemption through banks or distributors, where you will need to submit transaction slips to an agent. 

Exit loads associated with redemption

Most mutual funds encourage long-term investing and withdrawing funds before a specific period may result in an exit load. This fee is charged when investors redeem their investments early. The minimum holding period varies - equity funds usually have longer durations, while some debt funds allow shorter holding periods.

Exit loads are applied to discourage frequent withdrawals and cover any costs the fund may incur due to early exits. These charges differ across mutual funds and are generally calculated as a percentage of the withdrawn amount. Before investing, it’s important to check the exit load structure, as it can affect the returns if you need to withdraw early.

How can you avoid tax on mutual fund redemption?

To avoid tax on mutual fund redemption in India, you can implement several strategies. Here are some effective methods:

1. Invest for the long term

Holding your equity mutual fund units for more than one year qualifies the gains as long-term capital gains (LTCG), taxed at 12.5% on gains exceeding INR 1.25 lakhs. This is lower than the 20% tax on short-term capital gains (STCG) for units held for less than one year. Thus, long-term planning benefits from lower tax rates and compounding returns.

2. Offset gains with losses

Use tax-loss harvesting by booking losses in underperforming mutual funds to offset gains in other investments. If you have a capital loss from one investment, subtract it from the capital gains of another, reducing your total capital gains tax. This is useful in volatile markets where some investments might underperform.

3. Systematic withdrawal plan (SWP)

Implementing an SWP allows you to withdraw funds in smaller, regular amounts rather than a lump sum. This spreads out your redemptions, helping manage and reduce your tax liability each year. With an SWP, you can redeem investments systematically, keeping taxable income under control and leveraging the annual tax-free LTCG limit of INR 1.25 lakh.

4. Leverage tax-saving ELSS

Invest in Equity Linked Savings Schemes (ELSS) to benefit from tax deductions under Section 80C of the Income Tax Act. Contributions to ELSS are eligible for a deduction of up to INR 1.5 lakh from your taxable income annually, reducing your overall tax burden.

Charges to redeem mutual fund units

Several charges apply when redeeming mutual fund units, impacting the net returns. Here’s a detailed list of the standard charges:

1. Exit load - This is a fee charged by the mutual fund house when you redeem your units before a specified period, typically within one year of investment. The exit load usually ranges from 0.25% to 1% of the NAV of the redeemed units. It discourages early withdrawal and promotes long-term investment​.
2. Deferred sales charge (DSC) - Some funds charge a deferred sales charge if the units are sold within a predefined period. This fee typically decreases the longer the units are held.
3. Transaction charges - These are flat fees levied for processing redemption transactions. The amount can vary depending on the intermediary or platform used for the transaction.
4. Redemption fee - Some funds impose a redemption fee, usually a small percentage of the redemption amount. This fee is specific to certain mutual funds and is charged when units are sold.
5. Securities transaction tax (STT) - This tax is applicable only on the redemption of equity-oriented mutual funds. The current STT rate is 0.001% on the redemption value. STT does not apply to debt-oriented mutual funds.​
6. Tax implications - When you redeem equity funds within one year, you incur an exit load and must pay short-term capital gains tax on your gains. Short-term capital gains tax applies to units held for less than a year. For holdings exceeding one year, long-term capital gains tax is applicable, typically at a lower rate.

Before investing, always check your mutual fund’s specific terms and conditions to avoid unexpected costs.

In a nutshell

To be a financially sensible investor, you must know when to redeem your MF units. After all, exiting an investment is as critical a decision as entering it. Thus, you require extensive research and a proper evaluation to make this decision.

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