Disentangling the web

By: | Updated: February 3, 2015 1:35 PM

In ELSS, AMCs can no longer reinvest dividend income in the same fund. Why this is good for you

Asset management companies have been asked to discontinue the dividend reinvestment option under equity- linked savings schemes (ELSS). (Thinkstock)Asset management companies have been asked to discontinue the dividend reinvestment option under equity- linked savings schemes (ELSS). (Thinkstock)

Asset management companies have been asked to discontinue the dividend reinvestment option under equity- linked savings schemes (ELSS). This means they can no longer reinvest their annual dividend income in the same scheme.

According to the new guidelines by the Association of Mutual Funds of India (Amfi), investors who don’t wish to receive a dividend payout could opt for the dividend transfer plan, wherein the dividend amount could be re-invested in any other open-ended scheme of the mutual fund.

The ELSS money is mostly invested in shares and the investor gets tax deduction on investments up to R1.5 lakh under Section 80C. ELSS have a lock-in of three years, which is lower than most tax-saving instruments, such as Public Provident Fund, National Savings Certificate and five-year bank FDs. If a taxpayer invests up to R1.5 lakh in ELSS in a year, he can save as much as R46,350 in taxes. Mutual funds have been offering growth and dividend options, and dividend reinvestment as a sub-option. So, if the dividend is reinvested, it gets into a three-year lock-in.

Harshad Chetanwala, head, Customer Delight, Quantum AMC, says the guidelines are in the interest of investors as the dividend declared and reinvested gets into a cycle, which means that an investor might end up in a situation where he could never be able to redeem all units at a certain point. “Those who wish to get some income from their investment in ELSS should look at the dividend payout. On the other hand, those who would like to park their money for the long term should look at the growth option,” he says.

Any dividend reinvested is regarded as a fresh investment and the funds are locked in for another three years. WS Ravishankar, co-founder of Scripbox.com, a platform for buying and selling mutual funds, says availing of benefits from the growth scheme also requires the investor to hold on to the funds for a longer duration as these schemes do not pay dividend but continue to grow the NAV. Hence, in effect, ELSS investors have to stay invested for longer, whether they opt for reinvestment or growth. “If the investor is comfortable with the idea of staying invested, incremental investments in a growth scheme are a better alternative as they would enable him to build wealth over time. There is no real advantage in the dividend reinvestment scheme,” he says. Analysts say the dividend reinvestment plan didn’t benefit investors much. On the equity side, investors gained no advantage by opting for the dividend reinvestment scheme. This is because dividend income is tax-free for equity schemes and does not attract short-term capital gain tax if the holding period is more than a year. ELSS investors are required to stay locked in for a minimum of three years, which makes the investment free of dividend and short-term capital gains tax.

Gainful investment
Analysts say an investor must have some equity exposure for better long-term returns and ELSS is a good option as one does not have to look at the performance of individual stocks. By selecting a good ELSS fund, an investor not only diversifies his portfolio, but also gets better post-tax returns. Returns are dependent on the fund manager’s ability to pick the right stocks, though.

Since ELSS funds have more than 65% of their corpus invested in stocks, they are exempt from tax on long-term capital gains as is the case with any other equity fund. The dividend income is also tax-free.

The returns, however, will fluctuate depending upon the performance of the equity market and stock selection of the fund manager. Among tax-saving instruments, ELSS is the only option that gives tax-free dividends apart from likely capital appreciation.

ELSS funds also offer systematic investment plans (SIPs), which are ideal for salaried investors. By taking the SIP route, one can stagger the investments, which would, in turn, bring down the risk sizeably.

An investor can put as little as R500 in ELSS, unlike other equity oriented funds, where the minimum investment is R5,000.

Dividend options: What to opt for?
Mutual fund houses will now give the growth and dividend payout options to investors. Analysts say the growth option is ideal for the salaried class because of the compounding benefits. Under the growth option, the investor won’t get income during the duration of the investment but only after the tenure ends.

Anil Chopra, group CEO and director of Bajaj Capital, says investors should opt for the dividend transfer plan (DTP) as it is a better way to manage one’s finances unless hard-pressed for funds. “The dividend received from ELSS funds should be diverted to another scheme of the same fund house through DTP and can work with both equity and debt schemes. However, ensure that it goes according to your asset mix and risk appetite,” he says.

Similarly, Ravishankar of Scripbox.com says for those already invested in a dividend reinvestment option, the better idea would be to switch to dividend payout. “The investor can then take a decision where to invest the amount and not get limited to the schemes of the same fund. For new investors, selecting the growth option would be a good decision,” he says.

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