How Chit Fund Works
The basic necessity of conducting a 'Chit' is a group needy people called subscribers. The foreman—the company or person conducting the chit —brings these people together and conducts the chit. The foreman is also responsible for collecting the money from subscribers, presiding over the auctions, and keeping subscriber records. He is compensated by a fixed amount (generally 5% of gross chitty amount) monthly for his efforts. Other than that, the foreman has no specific privileges; he is just a chitty subscriber. A simple formula depicts the pattern of the chitty:
Monthly Premium × Duration in Months = Gross Amount
E.g., 5000 * 20 = 1,00,000/- Where 5000 is the maximum monthly contribution needed from a subscriber, 20 is the duration of the chit in months and 1,00,000 is the maximum sum assured. The duration also equals the number of subscribers, as there must be (not more or less) one subscriber to receive the prize money every month. The commission amount will be deducted from the priced amount.
The chit starts on an announced date, every subscriber come together for the auction/lot. As per chit act, the minimum prize money of an auction is limited to 60% of the gross sum assured that is 60,000 in the above example. When there is more than one person willing to take this minimum sum, lots are conducted and the 'Lucky subscriber' get the prize money for the month. If there is no person willing to take the minimum sum, then a reverse auction is conducted where subscribers open-bid for lower amounts; The person bidding lowest sum gets bid amount.
In both the cases the auction discount, after deduction the foreman commission that is the difference between the gross sum and auction amount, deduction foreman commission is equally distributed among subscribers after or is deducted from their monthly premium. For example if the auction is settled on a sum of 80,000, then the auction discount of 20,000 (1,00,000 - 80,000) is divided by 20 (the total number of subscribers) and everyone gets a discount of 750. The same practice is repeated every month and every subscriber gets a chance of receiving some money.
Benefits of Chit Funds:
Chit fund is a unique financial concept, which has flexibility to borrow or save. By paying one-month installment amount, a person can get to borrow from the chit value, by offering a discount not exceeding the maximum limit ascertained in the chit agreement. In a chit value of Rs.50000/- for a period of 50 months, first the subscriber can get an amount of 30000/-by paying only Rs.1000/- and remaining installments he pays over a period of 49 months. The rate of borrowing is much cheaper than several other financial schemes.
The non prized subscriber who is a saving member up to the last installments gets dividend which is comparatively higher than the interest that are accrued by way of Recurring Deposit Schemes. The purpose of drawing the prized amount need not be disclosed. It can be used for any need by the member for Example: House construction, Marriage, Education, Expansion of business or any other purpose at his discretion.
Tax Benefits:
TDS is not deducted for dividend.
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