TAX-FREE BONDS Archives - Hum Fauji Initiatives

I had written about Tax Free bonds a month back on my blog (read: https://humfauji.in/blog). There were many queries on the same. Hence, I felt the need to clarify some more on these tax-free bonds. In the meantime, the current crop of tax-free bonds on the block have improved in returns over the ones available earlier a month back, thus making them even better in their offering. The additional points that make these bonds attractive for the retiring and the retired persons are as follows:-

The returns are even better now. Consider the table below for the Power Finance Corporation (PFC) bonds:

Individuals	Retail (UPTO Rs 10 LACS)
Individuals	TAX FREE Coupon	*TAX BRACKET 10.30%*	*TAX BRACKET 20.60%*	*TAX BRACKET 30.90%*
10 Years	8.43%	9.40%	10.62%	12.20%
15 Years	8.79%	9.80%	11.07%	12.72%
20 years	8.92%	9.94%	11.23%	12.91%

Individuals	HNI (More than 10 LACS)
Individuals	TAX FREE Coupon	*TAX BRACKET 10.30%*	*TAX BRACKET 20.60%*	*TAX BRACKET 30.90%*
10 Years	8.18%	9.12%	10.30%	11.84%
15 Years	8.54%	9.52%	10.76%	12.36%
20 years	8.67%	9.67%	10.92%	12.55%

As can be seen, the returns given in the PFC bonds equal a fabulous pre-tax return of up to 12.91% per annum of that available from an equally safe instrument like bank FDs, PO MIS or SCSS.

Due to the very long time-frames of 10, 15 and 20 years of these bonds, these good returns are assured for long periods of time, resulting in consistent and good cash flows. Thus, the interest rate risks are mitigated for these long periods.
Another good aspect of the bonds is the lack of ‘Call’ option on these bonds by the issuer, thus removing the nasty surprise of the company deciding to call back the bonds any time in future. Such a surprise has affected large number of investors in the past in many other bond issues including in sovereign type of bond issues.
These bonds are very good for portfolio diversification. With the high assured return on investments and near zero probability of credit default, these bonds are very good portfolio diversification tool for any investor.
Some retired people have expressed a doubt how they can use the yearly interest for their monthly household expenses. It is rather simple. The yearly interest received can be comfortably invested in Liquid Mutual Funds which are currently giving approximately 8.2% per annum of safe returns. A Systematic Withdrawal Plan (SWP) can be set up for a monthly income on a given date every month. Eg, to get Rs 10,000 per month, take Rs 14 Lakhs worth of these bonds for 20 years. It will give you Rs 1.2 Lakhs per year, which can be used to get Rs 10,000 per month. In case you do not need the interest in a particular year or for initial few years, let the yearly interest lie in suitable debt mutual funds and start the SWP when you feel the need. You will get a higher corpus and would be able to afford higher monthly ‘income’.

These bonds are really a case of making hay while the sun shines in case you are the kind of investor who wants good but safe long-term returns.

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When we sent a promotional mail to our subscribers few days back, we received a good response for these bonds including from some very young persons. We quizzed some of them and found that they really did not understand the actual nature of these bonds. We were actually able to dissuade some of them not to apply for them while rang up some older subscribers to get to subscribe to them. Given below are clarifications on what are these bonds and to help you decide if they are for you:-

What is the Buzz about these Bonds?

This financial year (FY 2013-14), the Govt has allowed Nine Public Sector Units (PSUs) to issue tax-free bonds totalling Rs 48,000 Crores. Rural Electrification Corporation (REC) has already finished with one such offering, while HUDCO (Housing and Urban Development Corporation) is in the market with their issue currently. Others will also come subsequently during the Financial Year.

So, What Tax-rebate do I get on applying for these bonds?

There is no tax-rebate on application! You have to understand the difference between getting a tax rebate on application and a tax-free interest. In these bonds, all the interest you get is always tax-free but there is no tax-rebate on the application amount. This is very different from the Infrastructure bonds that came in FY 2011-12 which got you tax exemption on application amount up to Rs 20,000 under IT Act Section 80CCF but then their interest was fully taxable.

How good is the interest we would generally get on these bonds?

The interest, which is assured for the bond period that you subscribe for, is 8.39% for 10 year bond, 8.76% for 15 year bond and 8.74% for 20 year bond on the HUDCO bonds on offer presently. To get such a good assured interest for long periods from a PSU with a high credit rating is a very good preposition. You can expect similar rates from other issues too.

Are they suitable for me then if everything is so good about them?

You will have to keep a few things in mind when you apply for these bonds. Firstly, there is no cumulative interest option – you will get the interest compulsorily every year. Secondly, they may or may not be saleable in the open market if you wish to exit them later. If general market interest rates are high when you want to exit, market price of these bonds may be quoted low. Of course, if general interest rates are low, you will get a good market price. On the other hand, their interest rate is very attractive; you can buy bonds for as low as Rs 5000 and in multiples of Rs 1000 thereafter; as there is no tax on interest, there is no TDS applicable on them; and they are only being allowed to be issued by PSUs which have very healthy financial position.

You haven’t told me whether they are suitable for me…

To our mind, they are suitable only for people who need an additional regular income. Thus, if you are planning to use it to meet a big financial goal later or going in for it only because of good tax-free interest while you actually do not need this additional recurring yearly income, this avenue may not be for you. However, if you are retired or retiring or do need to supplement your current income on a regular basis, these bonds are excellent safe investments. Of course, yearly income issue (as opposed to monthly income) should not deter you since the annual interest received can always be parked in a Liquid Mutual Fund and a Systematic Withdrawal Plan (SWP) set up to give you a safe and regular monthly income.

Are these bonds better than long-term bank FDs where I have put my money?

The returns in fact come out far better than Bank FDs. Eg, SBI currently gives 9% interest (9.25% for senior citizens) on its bank FDs for period between 5-10 years (maximum period is 10 years). For a senior citizen who is in the 20% tax category (annual income between Rs 5 – 10 Lakhs), the effective rate of interest after tax comes out to be 7.34% only on such FDs. For non-senior citizens, it is even lesser. Compare this with the 8.39% to 8.74% interest being given by these bonds.

With regards,

Col (retd) Sanjeev Govila, CERTIFIED FINANCIAL PLANNER^CM, CEO,

Hum Fauji Initiatives^TM, Your Long-term Partner for Wealth Creation
E-511, 2nd Floor, Ramphal Chowk, Palam Extn, Sector 7, Dwarka, New Delhi-110077

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Tag: TAX-FREE BONDS

Revisiting Tax-free Bonds: Ideal Instrument for Retired and Retiring Persons

ARE TAX-FREE BONDS, BEING ADVERTISED NOW, SUITABLE FOR YOU?