Tax-free bonds are an ideal instrument for risk-averse retail investors...!

Tax-free bonds are an ideal instrument for risk-averse retail investors...!

1. Tax-free bonds are an ideal instrument for risk-averse retail investors.

2. Tax-free bonds are liquid and are issued by government-backed companies, and have high credit ratings.

3. This financial year, there will be no fresh issue of tax-free bonds. An investor can purchase tax-free bonds issued in the last few years from the secondary market and hold it for a long period.

4. Under these bonds, while the investor does not get any exemption under Section 80C of the Income-Tax Act, 1961, the interest accrued is completely tax-free under Section 10(15)(iv)(h).

5. Analysts say tax-free bonds are an attractive long-term investment and the volatility in equity markets will further draw retail investors towards them.

6. There is no deduction of tax at source from the interest that accrues to bondholders, irrespective of the interest amount or status of the investor. So, if an investor who has parked money in State Bank of India’s 10-year fixed deposit, which is offering 7% interest, and if he is in the highest (30.9%) tax bracket, the effective rate goes down to around 5%. The recent issues of National Highways Authority of India (NHAI) have yields of 7% returns and investors do not have to pay any tax on the returns.

7. Retail investors, comprising individual investors, Hindu Undivided Families (through karta) and non-resident Indians can invest.

8. Not having to pay tax on the interest earned on such bonds makes them more attractive than other taxable debt instruments, like bank FDs.

At the time of the issue of the bonds, there was a ceiling on the coupon rates, which was based on government security rates for equivalent maturity.

9. A triple-A rated issuer could sell bonds to retail investors at a rate that was 0.55% lower than similar maturity government bond yields and 0.80% lower in the case of other investor segments.

10. Any AA-plus rated state-owned firm could offer an additional 0.10% above the ceiling rate for AAA-rated entities and any AA or AA-negative rated entity could sell bonds paying an additional 0.20% above the ceiling rate for AAA-rated companies.

11. Before investing in tax-free bonds, one must look at the issue size as it may impact liquidity. For instance, NHAI’s Rs. 10,000-crore bond issue has the highest traded volume on bourses. One must also look at the credit rating of the issuer and the tenure of the bond.

12. Experts say long-duration bonds reduce re-investment risk and, as interest rates may come down in the long term, it’s better to lock in money in tax-free bonds.  For those in the higher tax bracket, tax-free bonds are an attractive option.  Bond prices and interest rates move in the opposite direction  when yields fall, prices rise and vice versa.

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