Tax saving funds are awesome, they are the best thing when it comes to saving tax! You have probably heard this enough and you are either tired of hearing that or irritated. So, instead, we’ll talk about a small technicality that a lot of people need clarity on.
The “Lock in period”
Of the two core benefits that work for you, the one that you probably paid a lot of attention to was the lock-in period of three years. This is the lowest lock-in for any tax saving investment.
So when does your investment actually become available for withdrawal?
Before you read the answer, this is what you need to know: The lock-in applies to the units of the mutual fund you purchased when you invested in that tax saving mutual fund. Think units and not the “investment amount”.
Your investments become available for withdrawal when the units you bought complete three years, irrespective of their value at the time of redemption.
How does this work?
Let’s say you invested Rs. 50,000 in tax saving funds in 2016. There are 2 ways you could have done it.
Way #1. Invest it all at one go.
Let’s say you waited until the last moment and invested the entire Rs. 50,000 in a tax saving mutual fund on 1st December 2016. Let’s say that the Rs. 50,000 investment got you 1000 units at a price of Rs. 50 per unit (that’s the NAV).
Now, the 1000 units you got are locked-in for 3 years. All of these units will be “freed” on 1st December 2019 and you can withdraw them on any date after that
But what if you didn’t invest it all at one go?
Way #2. Invest via SIP or in installments
Being a smart investor you decided to invest the same Rs. 50,000 in the tax saving fund in 5 installments of Rs. 10,000 each. Let’s say you did the following and this is what happened when you invested.
10 April 2016: Rs. 10,000 which got you 1000 units at an NAV of Rs. 10
10 May 2016: Rs. 10,000 which got you 900 units at an NAV of Rs. 11.11
10 June 2016: Rs. 10,000 which got you 1100 units at an NAV of Rs. 9.09
10 July 2016: Rs. 10,000 which got you 1200 units at an NAV of Rs. 8.33
10 August 2016: Rs. 10,000 which got you 800 units at an NAV of Rs. 12.5
Total number of units bought – 5000
Total amount invested – Rs. 50,000
(Note that I’ve played around a bit with the example NAV to get round numbers of units but also to remind you that in tax saving funds, NAV will go up and down)
When do these units become available for withdrawal?
Each installment is treated as a separate investment (even if you did it as a SIP) and each has a 3-year lock-in.
#1. On 10 April 2019, only your first 1000 units become available for withdrawal. The remaining 4000 units are still not eligible for redemption as they have not completed 3 years.
#2. your second, third, and 4th installments become available after 3 years are completed for each - on 10 May, 2019; 10 June 2019; 10 July 2019 respectively.
#3 On 10 August 2019, all the 5000 units become available for withdrawal.
Our take: ELSS or tax saving mutual funds are for all practical purposes equity mutual funds and should be considered for the long term. Withdrawing them after three years is not the best approach to take. Allow them at least 7 years to get the most benefit out of them.
Got some doubts? Ask them in the comments below! We would be happy to help.