As the last day for making tax-saving investments nears, inflows into equity-linked savings schemes (ELSS) are reporting a surge. With equity markets turning buoyant, retail investors are aggressively investing in ELSS to save tax. In order to boost investment sentiments, mutual fund houses are paying dividends to investors as most ELSS, or tax saving funds, have performed better than the benchmark Sensex and Nifty. In fact, in the past one year, these funds have reported around 23% returns as compared to the 50-share Nifty’s 16%.
Dividends in March
Most asset management companies declare dividends for ELSS during this month to encourage existing investors to invest and also attract new investors. Also, dividends received by the investors are tax-free. Analysts say fund houses pay 10-12% dividends, which is much higher than bank deposits.However, when the markets are in a a bear phase, fund houses do not declare any dividends. In fact, the markets regulator has mandated that fund houses can pay out dividends only from actual realised gains and not from reserves.
Mutual fund houses offer growth and dividend-payout options to investors. The growth option is ideal for a salaried individual because of the compounding benefits in the long run. In the growth option, the investor will not get income during the duration of the investment and will get it only when the tenure ends. This is ideal for those who are not looking at regular dividend payouts every year, but want final maturity payment along with the accumulated dividends for certain goal-based needs, such as higher education of children, wedding expenses, or down payment for buying a house or a car.
Tax benefit in ELSS
An individual can get tax deduction on investments up to R1.5 lakh under Section 80C of the Income Tax Act by investing in ELSS. Mutual fund houses invest ELSS money in stocks. The funds have a lock-in period of three years, which is the lowest lock-in period compared with other tax-saving instruments like Public Provident Fund, National Savings Certificate and five-year bank fixed deposits. If a tax payer invests up to R1.5 lakh in mutual fund ELSS in a year, then he can save as much as R46,350 in taxes a year in the highest 30% tax bracket.
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 the stock selection of the fund manager. ELSS is an equity investment and all the risks of equity investing apply.