What are Chit Funds and How to Invest in them?
The concept of chit funds have been in existence for quite some time now. It is a popular savings scheme for low income groups, salaried individuals and self-employed individuals. Though chit funds enjoy considerable hype in rural India, there have been a number of chit fund-related financial scams in the past.
If you’re planning to invest in chit funds, read this blog first.
What are Chit Funds?
A chit fund refers to a form of collective savings scheme in which a group of people agree to contribute a fixed amount of money to a common pool of funds at regular intervals. One member of the group is chosen by lottery or other means to receive the entire pool of funds for that period. The members of the group then rotate receiving the fund, with each member receiving the fund in turn as per the agreement. Chit fund is also termed Kuri and Chitty.
How Does a Chit Fund Work?
Under a chit fund scheme, a number of individuals make contributions towards the chit value at regular intervals for a period equal to the total number of subscribers or members (investors). A person, chosen through an auction or a lucky draw, receives the money collected.
Through an auction allotment system, an individual who agrees to receive this lowest amount (with the lowest bid) gets the money. It is known as a reverse auction system. The sum forgone by a winner is distributed equally among the other bidders post subtracting a foreman’s charges and commission. An amount that each bidder receives is termed a dividend.
A winning bidder will continue to invest even after agreeing to claim the sum. A chit fund starts at a pre-specified date. Members keep their monthly instalments in the pot. After that, an open auction takes place, permitting subscribers to bid for the value. A member who is ready to get the lowest amount is a winner. He/she receives the chit fund in that month.
What are the Different Types of Chit Funds?
Chit funds can be of five different types. You must know about each of them before making an investment decision.
1. Special Purpose Chit Funds
These funds work for a specific purpose. For instance, several men can form a group to start a savings scheme for Christmas cakes. The end date of such a fund will usually be one week before Christmas.
The group will use the collected amount to make cakes in bulk. After that, cakes will be distributed to the members at Christmas. Hence, special purpose chit funds minimise the efforts and expenses.
2. Organised Chit Funds
These funds are more prominent in North India, where members need to meet weekly or monthly. Small slips of papers with the subscribers’ names are collected in a box. The group’s person-in-charge chooses a paper slip from the box in front of the members.
A person whose name gets selected receives the entire fund. Then, that name gets eliminated from the box. The winner’s name will not be picked up again in the next meeting. However, he/she will be present there ─ contributing his/her share of money.
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3. Online Chit Funds
In this digital era, chit funds have been upgraded and are even available online. These kinds of funds organise online auctions. Furthermore, monthly contributions of the bidders and the prize money payment are made through online mode. Each member must have an online account to circulate and manage chit funds.
4. Registered Chit Funds
The Registrar of Firms, Societies and Chits offers registration to these chit funds. The Reserve Bank of India regulates such funds by enforcing the Chit Fund Act, 1982 throughout India.
5. Unregistered Chit Funds
Colleagues, family or friends organise these funds, which act as savings schemes. They are riskier as compared to registered chit funds.
What are the Features of Chit Funds?
Here are the major features of chit funds you ought to know before investing in them!
- Deposits from all the members lead to the accumulation of a lump sum amount.
- They serve as a means of financial assistance for lower-income households.
- These funds offer you a lower interest rate than moneylenders.
- They come with a predefined value and duration.
- Such funds work as micro-finance institutions.
- They are a combination of savings and credit schemes.
What are the Benefits of Chit Funds?
Chit funds can be beneficial to you in the following ways:
1. Multiple Usages
You can use these funds for various purposes such as children’s education, festivals, religious ceremonies, medical expenses, travel, shopping, and marriage.
2. Low-interest rate
Bidders determine the rate of interest mutually; it differs from auction to auction. Besides, chit funds keep lower interest rates for borrowers as compared to other financiers.
3. High Dividend
Investors receive a comparatively higher dividend than interests earned on the savings in multiple deposit schemes.
4. Urgent Cash
You can access instant cash during a financial emergency or meet a sudden expense. You also have the chance to borrow the pot (lump sum amount) after paying your first instalment.
5. No Queries
An applicant does not need to disclose why he/she is borrowing the money (the pot).
6. Collateral-free
You can borrow money without pledging any asset as collateral. It will only depend on personal sureties, unlike NBFCs and banks that require tangible security.
7. Less Or No Paperwork
It meets the financial requirements of the people without asking for details such as a PAN card and IT returns.
Things to Consider Before Investing in a Chit Fund
Listed below are some of the things you need to consider before putting your money in a chit fund:
- You must ensure that the chit fund is a registered company. You can approach the registrar of the companies to verify their certificate of incorporation.
- Do not forget to check the registration number along with certificates issued by the registrar of the state in which the chit fund company operates.
- Do not forget to find out details about the people running the chit fund. Checking their financial health is more important than you think.
- You can compare various chit funds based on the foreman’s commission. Consider choosing a chit fund with the lowest commission as it would be a wise decision.
- Before investing in a chit fund, make sure you have the finances to continue contributing throughout the chit fund cycle.
- Check whether there are any court cases pending against the chit fund company at the office of the Registrar of Chits of the respective State Government.
Final Word
Investing in a chit fund can be a fruitful option as its subscription amount is low and the maturity period is primarily short. Furthermore, they design investments to satisfy individual needs. You can effectively manage your finances through regular instalment payments.
FAQs
Ans: TDS is not applicable on chit funds because a foreman’s commission is not a part of the chit subscriber’s expense.
Ans: In India, the Chit Fund Act, 1982 regulates chit fund companies and hence they are safe and legal. They are not the same as Ponzi schemes and unregulated deposits. However, unregistered chit funds are risky since they’re not legal.
Ans: As per the Chit Fund Act, 1982, registration of a chit fund business can be carried out by the respective State Government. Under Section 61 of the Chit Fund Act, the government designates the Chit Registrar.
Ans: Yes, chit funds are eligible for GST. In the 47th GST Council Meeting, the decision was made to increase the GST rate on chit fund commission from 12% to 18%. However, no input tax claims can be made for the goods used for chit fund services.
Ans: From the point of view of income tax, the overall income is subject to taxation. However, dividend income from each month is not tax-deductible or taxable. You can claim any loss as a business loss.
Disclaimer
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
