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Dividend Reinvestment In TaxSaver Funds: A No-No


A very large number of us, me included, have invested in ELSS funds (Taxsavers). All investments in these funds are locked in for three years.

Some of us, me included, have used the “Dividend Reinvestment” option when going into such funds. (An option you should never use anyhow)

Dividend Reinvestment in Taxsaver funds is especially bad; you can never get your money out completely, since each investment is locked in for three years. Every year the fund announces a dividend, and typically they keep it quite high so that people invest. You have about five days after the announcement of dividend to buy and get that dividend. Why is this good? Because you can get a tax deduction on the whole amount invested (under Section 80C) and then get a part of your money back.

(Ex. SBI Magnum Taxsaver announced Rs. 11 dividend when its NAV was 55, a 20% yield. If you had about 90,000 available in 80C, you could have invested it in the fund and instantly got back 18,000, but got a tax benefit on the full 90,000).

Now why are dividend reinvestment options bad here? Because every year the dividend will get reinvested and locked in for yet another three years. You will never be able to completely withdraw from the fund, even if it underperforms like crazy.

You might think: Well, let them reinvest it every year, what difference does it make? It will contribute to some part of my section 80C investment anyhow, no?

Consider this: What happens if the government withdraws the 80C exemption, or decides that ELSS funds will not be part of 80C? Every year you will be reinvesting and locking in your money for three years further and getting no tax benefit.

Further consider what else comes under 80C. Housing loan principal for instance. So if you take a loan to buy a house, and if the loan is above Rs. 20 lakhs, you are sure to pay more than 1 lakh principal per year through your EMIs. So you don’t need another 80C investment. But the dividend reinvestment gives you no option but to keep investing and locking in your money.

Also under 80C is your childrens’ education fees. Given what schools charge today, that might well cover your 1 lakh limit by itself.

One thing you can do is attempt to speak to the fund house and change from re-investment to payout instead. Some fund houses are ok with this, but I can’t say for sure if all of them will agree.

And going forward, either invest in the dividend payout option or in growth – never the reinvestment option.


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