ELSS Schemes: -Tax Saving Financial Instruments

We keep hearing a lot on how to save tax in a financial year and how to find ways to pay less taxes. And with that we often hear the word Section 80C.What is this Section 80C of the Income Tax Act that we read every other day?

Section 80c of the Income Tax Act allows tax exemptions in certain expenditures and investments. The total limit under this section is Rs. 100,000. And another Rs. 20,000 has been exempted for investing in Infrastructure bonds according to the Budget 2010-11.So how do these ELSS Schemes fit into all this?

ELSS or Equity Linked Savings Schemes are diversified equity funds with tax benefits. Compared to the other options in Section 80C like NSC, PF, PPF it has some advantages over the others. So how do these ELSS schemes work? ELSS Schemes are like other mutual funds schemes apart from the fact that they have a lockin period and they offer tax benefits. Other Mutual Funds are open ended (You can enter anytime in the scheme and takeout your money anytime).But here you have a lock-in period of 3 years which means you cannot take your money out of the scheme before 3 years. It might seem odd to have a lock-in of 3 years for a mutual fund, but compare it with other tax saving investment avenues - the lowest lock-in is 5 years for bank fixed deposit (FD), and it can go all the way up to 15 years for Public Provident Fund (PPF). And this lock-in period helps.

Usually, fund managers keep a portion of the mutual fund corpus, around 7-10%, as cash, so that they can meet all redemptions. This cash is invested in very short term investments, generating meager returns. This impacts the overall returns of the MF. Since the fund manager of an ELSS knows that you would not withdraw your funds for 3 years, he can invest all your funds, and thus, no part of your investment would be sitting idle as cash. Thus, you get superior returns through ELSS.

And while you invest in them you get tax exemptions upto 1 lac. Earlier one could invest only upto Rs 10000 in ELSS Schemes but after 2006 the limit was removed. So a person who earns Rs 5 lacs per annum can get gross deduction of upto Rs 1 lac from the amount on which income tax is payable by investing in ELSS schemes; so he will have to pay taxes applicable only on Rs 4 lacs. There is no upper limit on investments that can be made in ELSS. However investments upto Rs 1 lac made in ELSS in a financial year qualify for deduction from taxable income under Section 80C of the Income Tax Act.

Apart from this other tax benefits include:-

1) Long term capital gains earned on investments from ELSS are tax free.

2) Also dividends earned from ELSS plan are tax free in the hands of the investor.

Also ELSS schemes offer some advantages over other options who avail Section 80C benefits.

1) Since it is an equity linked scheme earning potential is very high.

2) Investor can opt for dividend option and get some gains during the lock-in period

3) Some ELSS schemes also offer personal accident death cover insurance

4) Provides on an average 20 to 30% returns compared to 8% in NSC and PPF.

Another advantage is the SIP style of investment. Systematic Investment Plan as it is called helps investor to minimize risk and take advantage of volatile markets. So an investor can get 10 units when NAV is Rs 20 and 20 units while NAV is Rs 10 by investing Rs 200. So investing a fixed sum regularly helps to cover the market fluctuations by rupee costs averaging.

Also one big advantage is there is no upper limit on the amount that an investor invests but the lower limit is Rs 500.So if they offer such great advantages why not all people invest in them? It is due to some disadvantages they offer:-

1) Risk factor is high compared to NSC and PPF as it is linked to equity which is always risky.

2) Premature withdrawal is not allowed but it is allowed in other instruments in some specific conditions.

And the only disadvantage it has over other mutual fund scheme is that they have the lock-in period of 3 years which no other mutual fund scheme has.

ELSS offers the benefit of both wealth generation as well as tax savings. It imparts a financial discipline among the investors who have long term investment plans. The returns in the past have always been good for these schemes, for the simple reason that they have healthy corpus and are diversified among the stocks which give an opportunity to tap the benefit of their fundamental growth. It is also an attractive avenue for investments because the net yield for the investor is higher comparatively because of the tax advantages. So Investors start investing in these schemes, they will make you guys rich; If not by generating wealth then by reducing your tax burden.

Ankit.

SEBI vs IRDA Face-Off On The ULIP ban.

MUTUAL FUNDS

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. It is nothing more than a collection of stocks and/or bonds. You can think of a mutual fund as a company that brings together a group of people and invests their money in stocks, bonds, and other securities. Each investor owns shares, which represent a portion of the holdings of the fund.

ULIPs

Unit Linked Insurance Plan (ULIP) provides for life insurance where the policy value at any time varies according to the value of the underlying assets at the time. ULIP is life insurance solution that provides for the benefits of protection and flexibility in investment. It is a financial product that offers you life insurance as well as an investment like a mutual fund. Part of the premium you pay goes towards the sum assured (amount you get in a life insurance policy) and the balance will be invested in whichever investments you desire - equity, fixed-return or a mixture of both. In India investments in ULIP are covered under Section 80C of IT Act.

COMPARISION

Mutual Funds	ULIPS
Positioned as Short-Medium Term Products.	Positioned as Long Term Products.
For ELSS Schemes there is a minimum Lock-in period of 3 years.	According to new Guidelines there is a minimum Term Value of 5 years.
No Life Cover only good returns expected	Dual Advantage: Life Insurance + Decent Returns
Only ELSS Schemes provide tax break facility	All Premium paid is eligible for tax-break under Section 80c of Indian IT Act.
Upper limits for expenses chargeable to investors have been set by the regulator	No upper limits for expenses determined by the insurance company
Portfolio Disclosure is mandatory.	Portfolio Disclosure not mandatory.
Entry Loads have been abolished by SEBI for mutual funds.	ULIPs generally come with a huge entry load. For different schemes, this can vary between 5 to 40% of the first year’s premium.
Highly Liquid as a mutual fund can be redeemed or sold any time apart from ELSS schemes which have specific maturity periods.	Low liquidity. ULIPs generally come with a maturity of 5 to 20 years. That what ever money you put in, most of it will be locked-in till the maturity.

What is the Current Fuss ??

The recent controversial orders from Security and Exchange Board of India (SEBI) and Insurance Regulatory and Development Authority of India (IRDA) on insurance companies issuing insurance policies with ULIP have caused quite a fright amongst policy holders.

Let’s start of with defining the basic purpose of a ULIP. A Unit Linked Insurance Plan popularly known as ULIP offers you with insurance as well as investment. A part of the premium goes towards the insurance policy and the remaining balance is invested in the funds selected by you.

This is where the SEBI controversy comes into play. According to SEBI, ULIPs falls under the mutual fund category coupled with insurance policy. As per their norms an insurance company has to take their permission before issuing any policy with mutual fund or like mutual fund (read ULIPs).

But at the same time what is astonishing is the timing of the ban introduced by SEBI on ULIPS, for insurance companies have been selling ULIPs for years now.Some describe it as a case of one-upmanship between the SEBI and the IRDA, while a few others feel that it is a good opportunity to mend the ways of insurance companies that have not bothered to ensure transparency in ULIPs and the dozen charges and deductions that come with it.

But another theory doing the rounds is that the SEBI's ban on insurance companies from selling ULIPs is actually an attempt to protect the Mutual Funds industry. The Mutual Funds Industry witnessed a massive 17.39% drop in AUM(Assets Under Management) by the AMCs in the year 2009. The mutual funds business has seen a downturn since August last when the entry load on them was disbanded by the SEBI, making them less attractive products for the agents to sell, compared to ULIPs.

Mutual fund companies have not been paying commissions for agents who sell their products, since August last year due to the scrapping of entry load on mutual funds. On the other hand, insurance companies pay hefty commisions, of even 25 per cent, to agents selling ULIPs. So ULIPs are now more attractive products to sell for agents compared to mutual funds. This move by the SEBI appears to be an effort to protect the mutual fund industry which is under pressure.

So Will ULIPs become more transparent now?

While a section of the financial industry feels that this is a good opportunity to make ULIPs more transparent financial products, there is another belief in the industry that ULIPs are fundamentally flawless products and the onus lies on the agent to ensure clarity.

With ULIPs constituting over 90 per cent of portfolio of insurance companies and only the remaining 10 per cent comprising of pure-play insurance policies, is it not reason enough for SEBI to step in and assert its importance.

What most industry members seem to agree with is that the SEBI has enough reasons to raise the issue, though the timing is debatable and that more clarity is needed on jurisdiction of each regulatory body.

Ankit.