Until now, Equity Linked Service Scheme (ELSS) has been one of the first-choice mutual funds for investors. It has two benefits: it helps you save on tax and at the same time helps you invest in the stock markets.
The three-year lock-in period ensures that the investment is long-term and also is protected from market fluctuations.
Studies reveal that Rs 23,700 crore worth of ELSS schemes have been invested in May 2010 as compared to Rs 11,800 crore in May 2007. Between 60 lakh to 1.2 crore people consider ELSS as a tax-saving investment.
Impact of DTC 2011 on ELSS
But this interest in ELSS is set to change very soon with the advent of the 2011-2012 Direct Tax Code (DTC). Starting April 1, 2012, no new ELSS Mutual Funds will be exempted from taxes taking away the biggest unique selling point (USP) of ELSS.
This is likely to hit the investors as well as the mutual fund industry hard. Though tax benefits for existing ELSS funds will continue, investors are rushing to exit them. ELSS was considered a sort of starting point for budding investors as it allows them to enter the equity market.
However, the DTC is all set to change this. ELSS was the only investment option that allowed investors to access dividends during the lock-in period. And this was another reason that attracted people to ELSS mutual funds.
Should we still invest in ELSS?
The important point to be noted here is that according to the revised 2011 Direct Tax Code, only ELSS Mutual Funds initiated after April 1, 2012 will not be exempted from tax deductions.
This does not apply to already existing ELSS funds and funds made before the above mentioned date, so it would be wise to avail this offer while it is still available. There are two types of ELSS plans: growth option and dividend option.
Growth option: In this option, the investor does not get regular income during the duration of the investment. It is only when the tenure is complete or when the investment is prematurely cancelled that he receives the interest generated. The advantage of this is that the investor gets a lump sum amount when the investment matures but the disadvantage is that there will be no steady income until maturity.
Dividend option: This is the exact opposite of the growth option. The investor will have a steady amount flowing every month through the duration of the investment. But this is a risk as the income will be unpredictable and erratic. The main disadvantage of this type of investment is that at the end of the three-year lock-in period, the final value of the investment will not be much.
Dividend reinvestment option: There is a third option wherein the investor can invest the dividends generated from the ELSS fund.
But according to Section 80C, the reinvested dividends are not liable for tax deductions. Hence people usually opt for either the growth option or the dividend option instead of the dividend reinvestment option.
How to best reap ELSS benefits?
It should be remembered that DTC is just a draft bill and is yet to be passed as a law.
There is still a lot of time for that and significant changes are likely to happen in that time. So until it becomes an Act, investors should wait and not act in haste.
There is still a lot of time before the DTC comes into effect during the 2012-13 fiscal year. So it is important for the investor to have a strategy during the interim period.
This is especially important for those who are using the ELSS funds for completing their tax saving investments. It should also be noted that one can add to the ELSS investment before the transition to the DTC, which is a year from now
(The writer is the CEO of bankbazaar.com)