ELSS Dividend Reinvestment option – Phased out

Equity Linked Savings Scheme(ELSS) is one of the best tax saving options that we have right now. Mutual Fund houses have around Rs 36,257 crore as Assets Under Management (AUM) under various ELSS plans.

ELSS Mutual Funds offer tax benefits on the investments made under Section 80C of Income Tax Act, 1961. Also the redemption amount of ELSS is not taxable as the minimum lock-in-period of 3 years makes it long term assets which is tax-free under section 10(38) of Income Tax Act,1961.

While investing in mutual funds, you generally have two options, ‘Growth option’ or ‘Dividend option.’ You have to select either of it. Most of the Mutual Fund schemes (whether equity or debt oriented) offer both the choices/plans to its investors.

The ‘Dividend’ option has two more sub-options. They are ‘Dividend Pay-out’ plan and ‘Dividend Re-investment plan.’

(Investors who seek long term wealth creation generally opt for ‘Growth’ option. Investors seeking regular income invest in ‘Dividend Payout option.’ While dividend payout option pays the dividend declared by mutual fund to the investor, dividend reinvestment option reinvests dividend amount in the scheme itself.)

What is the lock-in period for ELSS Funds?

You may be aware of the fact that ELSS Funds have a 3 year lock-in period. This is applicable for both lump sum and SIP (Systematic Investment Plans) investments. Mutual Fund Units that are allotted under each SIP installment have 3 year lock-in period.

What is the issue with ELSS Dividend Reinvestment option?

Investments in tax saving ELSS (whether lump sum or SIP) with Growth and Dividend Payout plans do not have any issues.

But, let us say an investor chooses ‘Dividend Reinvestment option’ while investing in Equity Linked Saving Scheme. What happens in this case when AMC (Asset Management Company) declares dividends?

Each unit allotted to the investor after a dividend announcement is reinvested in the scheme. These newly allotted units get locked-in again for three years. This leads to a loop of transactions that keep investing money in scheme, which further makes it difficult to withdraw the entire balance.

Investors who wish to redeem/withdraw all the units (the entire balance including dividend reinvested) after three year lock-in period of the original investment cannot do so, due to lock-in of each transaction of dividend reinvestment, leading to confusion and investor grievances.

(Even if an investor does not opt for ‘Dividend payout sub-option’ under the ‘Dividend plan’, the default option is treated as ‘dividend reinvestment’ only)

This matter was discussed by SEBI (Securities and Exchange Board of India) with AMFI (Association of Mutual Funds in India) recently. After examining the issue, the AMFI committee on Operations and Compliance recommended that ELSS dividend reinvestment should be discontinued to avoid any confusion in the minds of investors. Some AMCs have already discontinued dividend re-investment options in their ELSS schemes.

Discontinuance of ELSS Dividend Reinvestment option: Impact on Existing & New investors

Going forward the mutual fund houses do not offer ‘Dividend Reinvestment’ option for their ELSS tax saving MF schemes. These schemes will have two options – Growth (or) Dividend payout only.

The existing unit holders of ELSS schemes (who opted for reinvestment option) will get dividend payouts whenever AMCs declare dividends. AMCs will convert the outstanding units under dividend re-investment option into dividend payout. The dividend monies will be credited to investors’ bank accounts. This is applicable to existing SIPs too.

The existing Investors who do not wish to receive dividend payout can opt for a Dividend Transfer Plan (DTP) through which they can invest the dividend in any open end scheme within the same fund house. If you want to opt for DTP, you have to submit DTP form to the respective AMCs (mutual fund houses). DTP form can also be submitted to Registrars or Transfer Agents (CAMS, KARVY etc.,).

Kindly note that some mutual fund houses may have ‘minimum dividend amount’ condition (like dividend amount should be atleast Rs 100 or so) to execute dividend transfer transactions. If the dividend so declared is less than this, then the money is credited to investor’s bank account irrespective of his/her dividend transfer instruction.

(Important point : The dividend reinvested amount does not qualify for any income tax deduction under Section 80c) (Image courtesy of junpinzon at FreeDigitalPhotos.net) (You may like visiting my post on “Top 5 Best ELSS Mutual Funds to invest in 2015.”)