FD Rates Falling Apart-Will You Invest in Tax-free Bonds?

Call it the effect of new benchmark interest rate (MCLR) or the greater flush of bank deposits in the wake of demonetization, the FD rates are on a constant decline. A couple of years ago, FD rates were sitting at 6.75%-9.25% based on various tenures of the deposit. But now, it has nosedived to 3.5%-6.5% on an average, raising question marks over the survival of those depending on this mode of investment.

Readers must note when the loan rates ease, even the FD rates go down. And this normally happens when the banks have a steady flow of deposits, which demonetization had brought about in a big way. State Bank of India (SBI) cut the retail fixed deposit rates on an amount of upto ₹1 crore by 25-50 basis points on various maturities. Bank of Baroda (BoB) has also slashed the FD rates by 10-25 bps. And there are other banks as well which are busy cutting the fixed deposit rates.

So, even if the fixed deposit rates are declining, you can’t wait to see your income nullifying to become almost insufficient to deal with the inflation that’s coming with all the weapons to bite your wallet the hardest way. At the present moment, tax-free bonds are doing the rounds. But before putting your hard-earned money won’t you like to know in details about tax-free bonds? I am sure, you would want to know it, right! So, why not keep a session on tax-free bonds today and get aware of its functions, advantages and even the disadvantages.

What is Tax-free Bond and How Does it Function?

A bond is typically a fixed income instrument bearing a coupon rate of interest. It is issued for a fixed period of time. Tax-free bond is an instrument that allows investors to earn interest without having to pay tax on the same. Even TDs do not apply to such bonds. As said, the tax benefits are available on the interest earned and not so on the actual amount of investment, which will come under the eyes of the taxman. Even the TDS would be there on the application money as required in a particular tax-free bond. These bonds are also listed on the stock exchanges, and on a capital gain resulting from selling the same, the applicable taxes will be deducted from an investor’s account. If you redeem the bonds before a year, you would be liable to pay tax as per the slab to which you belong. After a year, a tax rate of 10.30% is levied on the gain. Also, you do not get the benefit of indexation, which actually is a tool that helps adjust the income according to the inflation.

How Do Issuers Decide About Interest Rate?

Based on the yields of the government securities at the time of issuance, the tax-free bond issuers can set the interest rate for the investors to enjoy. It remains fixed throughout the moment it is set and offered. There are two factors based on two factors-Issuer’s ratings and status of an investor (retail or high net worth). AAA-rated tax-free bonds may attract an interest rate of 0.5% minus the rate prevailing on government securities. The other rated bonds would have an interest rate of 0.8% lower than G-sec rate.

Difference Between Retail & High Net Worth Investor

Investors who invest an amount of upto 10 lakhs in each issue get the tag of retail partIcipants, while those exceeding the said investment limit elevate to high net worth category.

Period of Investment

Talking about the tenure of these bonds, they are generally issued for a period of 10-20 years.

Advantages

• It is one of the most attractive investment options for high net worth class of investors. Since tax-free bonds allow lump sum investment, this investor class finds it appealing.

• As issued by government institutions such as IRFC, NHAI, HUDCO, NHPC, NTPC and others, they are generally considered as a safe heaven for investing your money.

• These high rated instruments instill a great deal of confidence on the part of investors.

• Returns are free from tax.

Disadvantages

• Since it is a long-term investment, people with short-term goals may not find it a great investment tool.

• The liquidity is on the lower side.

• Interest payment frequency is generally annual, while the interest payment frequency of 6-month is often at a reduced rate of 0.15% than normal.

It can be said that you are now in a position to take a call on tax-free bonds. Keep some basic things like your investment goals in mind before parking your money in these bonds. A highly rated bond is where your eyes should be while picking from the lot.