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Product Review – Long term tax free bonds


Currently, the market is flooded with a host of tax free bonds of 10 year and 15 year duration. There are as many as nine such IPOs which are on. All from government companies with a high safety rating and low credit risk –

Company

Interest Rates for 15 years

Pre-tax yield – 30% tax bracket

HUDCO

7.69%

11.13%

Ennore Port

7.67%

11.10%

IRFC

7.54%

10.90%

PFC

7.54%

10.90%

REC

7.54%

10.90%

IIFCL

7.52%

10.88%

 Dredging Corporation

7.47%

10.82%

Jawaharlal Nehru Port Trust

7.32%

10.60%

NHB

7.32%

10.60%

The volatile and uncertain performance of the equities market has resulted in investors opting for safe returns from fixed income schemes. Yet, these schemes do not seem to be getting a great response.  Bank and company fixed deposits, fixed maturity plans and capital protection plans of up to 3-5 year duration are more popular. Some of the reasons of this could be

  • Investors do not like to think too ‘long term’, beyond maybe 5 years. They hesitate to invest in schemes which of longer duration.
  • The greatest disadvantage is lack of enough liquidity. Though these bonds can be traded on the exchange if held in dematerialized form, the volumes are very low and doing that would mean that the investor gets a much lower yield. And, he is also liable to pay capital gains tax at the applicable rates(long term if sold after an year @ 10 %, or 20 % with indexation) . So, the bonds lose their ‘tax free’ property.
  • Interest rates are on a downtrend today. But since interest rate trends tend to change/reverse after every few years, a small section of investors may feel that if the interest rates rise again in a few years, or if the stock markets become favorable, they may lose out by locking in their funds now for such long periods at the current rate.

Why, who and how much should one invest in these ?

  • The higher the income tax bracket you fall in, the more attractive these bonds are for you. For someone in the 30 % tax bracket, the differential tax adjusted yield is much higher than for those with a lower percentage of tax liability; hence it is worth investing in spite of the long lock-in period.
  • Invest only a small fraction of your funds- that you can spare for 10-15 years without the pressure of withdrawal. These schemes are best suited to meet long term goals like saving for retirement or future higher education or marriage of a young child.
  • Before allocating your savings to these, do consider and give priority to other similar tax free avenues available like Public Provident Fund – which offers partial liquidity after 5 years, and after exhausting the maximum investible limit in these, tax free bonds may be considered.

DISCLAIMER : All the views expressed here are just for informative purposes and do not constitute or indicate any kind of investment recommendation.

 

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