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Tax-Free Bonds: A Risk Free Investment

In Financial Planning, Taxes by Mayank Mundra0 Comments

The recent swings of the equity markets can dishearten even the long-time investors. Almost all the funds have taken a tumble in the last one month. This is why RupeeVest recommends you to have a well balanced portfolio with a share of risk free investments. Tax-free bonds are an effective and surprisingly uncommon tool to do that. So what are tax-free bonds? Why are they better than other risk-free options such as Fixed Deposits? How can one invest in tax-free bonds?

Tax-free bonds are generally issued by government-backed entities to raise funds for capital intensive projects. The interest they pay is tax free, so effectively a tax-free bond paying 7.5% interest is better than a FD which pays 8% interest because you have to pay tax on that interest depending upon your tax bracket. So for example, if you come under the 20% tax bracket you end up getting 6.4% interest and not 8%, whereas had you invested the same amount in a tax-free bond which paid you 7.5% interest you would have received the whole 7.5%.

Tax-free bonds generally have long maturity periods of 10-20 years but they are listed on the stock exchanges offering an easy exit route. Also in the long run FD interest rates will get even lower (3-4 years back, one could easily get an interest rate of 9% but that is not case now), and as interest rates get lower, prices of tax-free bonds get higher so apart from your interest your invested capital also increases. However, the capital gain made through selling of your tax-free bond is taxable which means if you bought bonds worth 20,000 and if you sold them at 21,000 before even getting your first interest payment, then the profit of 1000 is taxable.

More than 10,000 crore of tax-free bonds from different PSUs such as NTPC, Power Finance Corp. (PFC), Indian Railways Finance (IRFC) Housing and Urban Development Corp. (HUDCO) are set to hit the market in the next two months which provides a very good opportunity to retail investors to buy these bonds.

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