Save smart: Make the switch from regular to direct MF plans

These are times when most mutual funds across categories are struggling to match, let alone exceed, their respective benchmarks’ returns. In this light, any lowering of fund charges can boost the overall returns and help funds outperform, at least marginally.

Shifting from regular to direct plans of funds can reduce expenses by 50-120 basis points, as there would be no distributor commissions. For long-term investment of five or more years, the difference in returns can be substantial.

As an investor, you need to be aware of the ‘how to’ and ‘what after’ of moving to direct plans, apart from being in the know of cases when switches are not allowed. These are explained below.

Investors must note that direct plans are suitable only for informed investors who are capable of taking suitable decisions by analysing schemes. Beginners and investors with very little time on their hands should avoid this option.

You can switch from the regular to the direct mode online as well as offline. If you have been investing through the websites of asset management companies, you need to go to each fund house and make modifications. The portals of CAMs, Karvy and MF Utility, too, allow you to make online switches.

After you log into your account, you will have a switch option. Choose the schemes that you wish to switch, and ensure that you click on the direct option. For SIPs, you need to start a fresh mandate after cancelling the previous one.

If you wish to change over to direct plans offline, you can walk into the office of your fund house or any of the other utilities mentioned earlier and ask for a switch form. Fill up the form and submit it to the entities.

Tax and cost angles

A move from the regular plan of a mutual fund scheme to the direct one is considered a sale and subsequent reinvestment of units.

This is so even if you move to the direct plan of the same scheme that you had held earlier.

Units will be sold, and for the equivalent realised value, you will be allocated units under the direct plan of the fund that you switched to.

Therefore, capital gains tax comes into the picture when sale of units takes places. In the case of equity funds, you will have to pay 10 per cent tax on long-term gains in excess of ₹1 lakh (made after a one-year holding period).

Short-term gains are taxed at 15 per cent. For debt funds held for three or more years, a 20 per cent tax on gains is to be paid, but the benefit of indexation is available to investors.

Short-term gains are added to your income and taxed at your slab when you sell debt fund units.

Some funds also charge exit loads on units sold within a specified time period. The holding time needs to be 1-3 years for some funds in order to avoid paying exit loads. Funds charge 1-3 per cent if units are exited before a specified period of time.

Thus, you need to calculate whether the benefits of moving to a direct plan outweigh the potential costs involved within your investment horizon.

You can avoid the exit load if you shift from the regular plan to the direct plan after the specified lock-in period. To avoid capital gains tax on equity funds, you need to do two things.

One, do the shift after holding the fund for at least 12 months — this will make the gains long-term.

Next, shift such funds to the extent that gains on equity shares and equity mutual funds do not exceed ₹1 lakh a year; only gains above this limit are taxed at 10 per cent.

Restricted exit

Investors must note that this switch option is not available in all cases and with all types of funds. You cannot exit closed-end funds before a pre-defined time period. Many debt and even equity funds have a specified lock-in.

Since the units cannot be sold earlier, you cannot switch over to the direct plans of such funds.

Another category of funds that cannot be exited, for a three-year period at least, is tax-saving schemes.

Since there are tax benefits under Section 80C for such funds, premature exit or withdrawal is not allowed. Therefore, investors cannot switch from the regular to the direct option before the stipulated lock-in.

Of course, it goes without saying that any investment done through a third-party distributor portal or platform is allowed through the regular mode only (we are not referring to the direct-only mutual fund investment apps and portals available). So, a switch to direct plans is not possible with such platforms.

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