Switching from regular to direct mutual funds: Know the hidden tax cost — and when the move actually pays off

Both direct and regular plans of a mutual fund have the same portfolio and are managed by the same fund manager. The key difference is the expense ratio.

Regular plans have higher expenses, which reduce their NAV compared with direct plans. Over time, the lower expense ratio of direct plans can translate into higher returns as the investment compounds.

This often prompts investors to switch from regular to direct plans. But there are hidden tax implications and other factors you must consider.

Says Mukesh Kumawat, Executive Director, Anand Rathi Wealth, “Switching from a regular plan to a direct plan of the same mutual fund is treated as redemption of the existing units and a fresh investment in the new plan.”

The same treatment applies when switching from direct to regular plans.

He added that direct and regular plans have different ISINs and are therefore treated as separate investments for tax purposes. The same applies to switches between Growth and IDCW options, as each has a separate ISIN.

“Any capital gains arising on the redemption are taxable in the year of the switch,” Kumawat stated. The tax treatment remains the same whether the switch is made through an investment platform, broker or directly through the AMC.

Suppose an investor has a lump-sum investment of ₹ 1 lakh in the regular plan of a large-cap fund. The regular plan has an expense ratio of 1%, compared with 0.5% for the corresponding direct plan.

The investor has remained invested for two years, during which the fund has generated an average annual return of 10% before expenses.

Kunawat noted that “there are multiple factors to consider, so the decision should not be based only on the expense ratio”.

Disclaimer: This story is for educational purposes only. The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.

Sheetal Goel is a Content Producer at Livemint, where she covers corporate developments, personal finance, business trends, markets, and SEBI-related updates. She focuses on simplifying complex financial concepts and presenting them in a clear, reader-friendly manner, thereby helping audiences better understand investment trends, personal finance, and market developments. Her writing focuses on making finance more accessible to everyday readers while maintaining clarity, accuracy, and relevance. <br><br> She holds a degree in Economics (Hons.) along with an MBA in Finance, which has helped her develop a strong foundation in financial analysis, market understanding, and business reporting. Before joining journalism, she worked with finance and broking firms, where she closely followed market developments, investment strategies, and evolving industry trends. This practical exposure strengthened her understanding of financial markets. She has also written content across multiple formats and platforms, including YouTube, LinkedIn, and Instagram. <br><br> Over time, she has developed expertise in covering market-linked stories, investor-focused topics, and regulatory updates in a simplified yet informative style.