Recently I came across this headline “Invest for 3 years – Save Tax For LIFETIME”. Sounds eye catching right? Because for many of us tax is the only force which makes us invest. Let us try to understand such GIMMICKS in detail 🙂
Here, the product recommended for investment is ELSS (Equity Linked Savings Schemes) or Tax Savings Equity Mutual Funds. Hence, let us quickly understand what is ELSS or Tax Saving Equity Mutual Funds.
Which mutual funds are considered as ELSS or Tax Savings Funds?
ELSS or Tax Savings Funds were first introduced in the year of 1991. The maximum limit to claim was Rs.10,000 under the Sec.80CCB. Then this section was merged with IT Sec.88 with the same limit for ELSS Funds.
Later on, this Sec.88 was replaced with current Sec.80C. This Sec.80C has become effective from 1st April 2005 (FY 2005-06 or AY 2006-07). The current maximum limit for ELSS investment is Rs.1,50,000 per year.
These ELSS Funds comes with lock-in. Let us say you invested Rs.1,50,000 on 15th June 2017, then you are eligible to withdraw it only after 15th June 2020. Same way let us say you started a monthly SIP of Rs.10,000, then each such SIP is considered as a fresh investment.
Hence, each such monthly SIP must complete 3 years to be eligible for withdrawal. Let us say you started a monthly SIP of Rs.10,000 from 15th June 2017, then the 15th June 2017 month SIP will be eligible for withdrawal after 15th June 2020. The next month SIP i.e. 15th July 2017 month SIP will be eligible for withdrawal after 15h July 2020. This will continue for the next months.
Such ELSS funds invest in 80% equity and convertible bonds at all times. They can hold 20% in cash or money market instruments to handle redemptions. The 80% equity can be managed as per the wishes of the AMC. They can be large-cap, multi-cap or mid-cap funds.
Hence, all ELSS FUNDS ARE NOT SAME. They may be an equally risk like a small cap or mid cap funds. Risk varies based on the underlying stocks or portfolio.
Also, note that ELSS funds can only invest in equities and bonds that are convertible to share. Investing in Arbitrage opportunity like Arbitrage Funds is not allowed.
Liquidity or lock-in feature in ELSS or Tax Saving Funds
As I pointed above, investors will not be eligible to withdraw the money for the three years from the date of allotment of units. However, in case the death of investor, nominee or legal heir can come out from the investment only after the completion of one year from the date of investment. Hence, even in a case of death also, your nominee or legal heir has to wait for a year to liquidate the investment.
Hence, if investor alive then he can liquidate the investment after the three years completion. If he dies, then his nominee or legal heir can liquidate the same after a year of completion from the allotment of units.
When it was first replaced with Sec.88 in the year of 2005, then the limit was Rs.1,00,000 a year. Now it is at Rs.1,50,000 a year.
Invest for 3 years – Save Tax For LIFETIME!
Now you get a fair idea about ELSS funds. Let move on to the topic, which we are discussing.
As per this, you have to invest Rs.1,50,000 a year for 3 years. After 3rd year completion, you have to withdraw the money which you invested in the first year and re-invest the same in ELSS funds and claim the rebate under Sec.80c. Same way you have to withdraw the second year invested money in the 5th year and invest uunderELSS. This will continue as long as you alive.
Let us say you invested Rs.1,50,000 in FY 2017-18.
Again you invested Rs.1,50,000 in FY 2018-19.
One more time you invested Rs.1,50,000 in FY 2019-20.
Then, you are eligible to withdraw the money you invested in FY 2017-18 in the year of FY 2020-21. You withdraw the money in FY 2020-21 and reinvest the same in ELSS Funds and claim the benefit under Sec.80C. You continue this throughout your life (Assuming you invested lump-sum for the first three years and same lump sum you are investing in future).
As such ELSS are considered as equity funds, the returns which you receive from such funds are exempt from tax (if holding period is more than a year).
Sounds GOOD!! Now worries of tax saving or no fresh fund required to save tax. Route the same old invested amount into ELSS and claim benefit throughout the life.
However, such logic not works when it comes to equity investment. Reasons are as below.
# Enter into equity if your holding period is more than 5 years.
Many of us enter into ELSS because it is tax saving instrument which is having minimal lock-in when you compare with other tax saving options.
But do remember that this is the equity product and above that, you are not sure the underlying stocks. Hence, you must enter into equity (or ELSS) only if your holding period is more than 5 years and that also with proper asset allocation.
If you follow this rule, then you are unable to follow that GIMMICK.
# Investing does not mean Tax Saving
Many of us feel that we have to invest because we have to save tax. But the reality is, you must identify the goals, then based on the goals time horizon and risk appetite you have to choose the asset class or products. While choosing the products, you may look for tax-efficient products.
However, we are doing the reverse. We first choose the product which is eligible to save tax. Then we think about rest of the ideas.
If you follow this rule, then you are unable to follow that GIMMICK.
# ELSS is not TAX SAVING BANK FD or NSC
Many used to follow this strategy of re-investing into tax saving instruments by using the Tax Saving Bank FDs or NSC products. But they have definite returns declared at the time of an investment itself.
Hence, it is not worrisome. However, in a case of ELSS, it is market linked. Let us assume that you invested Rs.1,50,000 today and due to crash in the market, the same may be valued at Rs.1,00,000, then you still go ahead and liquidate after 3 years as you have to save tax??
NO right? Hence, it is better to understand the volatility or risk involved in a product rather than blindly using some gimmick.
# This is the Mutual Fund Advisers GIMMICK 🙂
Yes, this logic is created by mutual fund advisers. If you follow this gimmick, then their income is also GUARANTEED as long as you are alive. Because you are in a trap called TAX SAVING and they are getting their income as long as you invest and hold the same.
# You lose habit of investing
Because of this trap, you just routinely redeem and re-invest in ELSS funds. In such situation, the fresh investment may be diverted to spending or somewhere. This leads to big financial hazard especially when it comes to accumulating the wealth for long-term goals like kids education or marriage and retirement.
The more you invest from your savings leads to reaching your financial goals at the early. Hence, this gimmick makes you away from saving and investment habit.
Considering all these above points, do you still feel the idea of “Invest for 3 years – Save Tax For LIFETIME!” worth to implement and that also with the product like ELSS??