Which are the Best Tax Free Bonds 2020 in India? All of us desperately look for two options when we invest. The first one is the TAX-FREE and the second one is FIXED RETURNS. In that case, Tax Free Bonds are the best choice for you.
Interest rates are falling, Bank issues popping up daily and Debt Funds are turning to be riskier than equity. In such a scenario it is obvious that one must look for some decent tax-free returns.
Currently, banks are offering you around 6.5% interest rate. This interest income is taxable as per your tax slab. Hence, suppose you are under 30% tax slab, then the post tax returns will be 4.55% (6.5%*((100-Tax Rate)/100)). Same way if you are under 20% tax slab, then the post tax returns will be 5.2%.
However, many of us not explored the other avenues and one such option is tax-free bonds. The current yield on such tax free bonds are around 6%, which is tax free and far far better than the typical Bank FDs.
What are Tax Free Bonds?
Tax Free Bonds are debt products. Usually in India Tax Free Bonds are offered by Government Public Sector Companies like NHAI, NTPC, HUDCO, REC, REL, IREDA or PFC.
In simple terms, you are lending money to these Government Public Sector Companies. In return, they promise you to pay certain interest on a yearly basis until maturity. Such yearly interest is called a coupon in the bond market.
The yearly interest that you receive from such tax-free bonds ise tax free in the hands of the investors. Hence, they have an advantage of safety (as these are Government Organizations) and tax-free income.
Hence, one can include such tax free bonds who are looking for yearly tax free returns for the long term.
Usually, the bond maturity is long term like 10 years, 15 years or 20 years. Hence, we may say as these tax-free bonds are tax-free, secured, redeemable and non-convertible in nature.
Many of us are unaware of these options. As these bonds are listed on stock exchanges like NSE or BSE, one can buy these bonds or sell them in a secondary market (even though the liquidity is a concern as the trading volume of these bonds are very less).
Individuals or HUF can buy such bonds. Currently, there are no such options available in the primary market. Hence, we can buy it from the secondary market.
There is no maximum limit for investment and also the interest payable is on a yearly basis. At maturity, you will get the face value you invested. The interest will be payable annually to your bank account directly.
How do I buy Tax Free Bonds?
As of now, there are no such offerings directly in the primary market. Hence, the only option for us is to buy them from the secondary market like NSE or BSE. The Bonds which are already available in the secondary market are older bonds with varying maturity years.
Difference between buying from Primary Market to Secondary Market
There is a huge difference in buying the tax-free bonds from the primary market to the secondary market. Hence, you have to understand it with the utmost care.
When you are buying the tax free bonds from the primary market, the buying price is the same as that of the face value of the bond. It means, if the face value of a bond is Rs.1,000, then the bond is available for you at Rs.1,000 itself.
However, when you buy the tax free bonds from the secondary market, then the buying price is not equal to the face value of the bond. Suppose the face value of the bond is Rs.1,000, then it may be available at a discounted rate or at a rate higher than the face value of the bond.
Hence, based on the bond price and interest rate you will receive till maturity, the bond yield will vary. If the price of the bond is lesser than the face value, then the yield for holding such bonds will be higher. Same way, if the price of the bond is more than the face value, then the yield of holding such bonds will be lesser.
The meaning of yield in simple terms is the return you will receive by investing in the bond. The yield on the bond will be inverse to the price of the bond.
What is the meaning of YIELD on Tax-Free Bonds?
As I said above, the yield is the RETURN that you will get it by investing in the bonds. Let me simplify this concept. Because it is very much important to understand the concept of yield when you are investing in bonds.
Assume that you are buying a Bond, whose face value is Rs.1,000, tenure is 10 years and the price is also Rs.1,000 with coupon rate at 8% (yearly interest).
In such a case, the YIELD will be 8%. Because it means by investing Rs.1,000 (which is same for face value and price of the bond), you are receiving 8% yearly income up to 10 years.
However, assume that suddenly RBI increased the interest rate. Assume that there are other options that are offering you higher returns than 8%. Hence, no one will buy such 8% yield bonds. In such a case, the price of this particular bond will fall. Hence, even though the face value remains the same i.e Rs.1,000, the price of the bond may fall. Assume it fallen to Rs.900.
Now those who buy these bonds will earn more than those who purchased it at Rs.1,000 right? Because of those who purchased by investing Rs.1,000 and those who purchased by investing Rs.900 will earn the same interest rate of 8%. However, those who purchased at Rs.900 will have lesser investment to earn the same 8% returns.
Hence, whenever the price of the bond (NOT THE FACE VALUE as it will remain same and will never change) goes up and down, then the yield on your investment will go up and down. Hence, while buying the bond, if the price of the bond is lesser than the face value, then the yield will be higher than the coupon rate. However, if the price of the bond is more than face value, then the yield on the bond is lesser than the coupon rate.
Taxation of Tax Free Bonds
As the name suggests, the interest income that you will receive from such tax-free bonds will be tax-free. Also, there is no concept of TDs on whatever the interest you will earn. Because the returns are tax-free.
However, you purchased the bond and in the middle if you wish to sell it off in a secondary market like in NSE or BSE, then based on the capital gain and holding period, you have to pay the tax on the purchase.
If the holding period is less than 12 months, capital gains on the sale of tax-free bonds on stock exchanges are taxed as per the tax rate of the investor. If bonds are held for more than 12 months, the gains are taxed at 10%.
Things to consider before buying Tax Free Bonds
# Coupon Rate-It is the interest payment you receive on your bond. But do remember that Yield is different than coupon rate if you buying from the secondary market.
# Current Yield-It is the actual return you will receive from investing in such a bond. If you are buying the bond initially at the time of issuing, then the coupon rate is your yield. However, if you are buying from secondary market, then the yield varies based on the price of the bond.
# Maturity Date:-It is the date on which you receive the face value of the bond. However, if you purchased it from secondary market, then irrespective of the price at which you purchased, you receive the face value ONLY not the actual bond price at which you purchased.
# Credit Rating-Even though these tax-free bonds are offered by state-run companies like NHAI, PFC, NABARD, HUDCO, IRFC, etc., it is better to cross-check the ratings of such bonds. Usually, higher the rating means lower the returns. Do keep one thing in mind that the current rating is not the constant rating. Credit rating companies may change the rating whenever there is an issue with the company’s financial health.
Best Tax Free Bonds 2020 in India
Let us move on and understand the current available bonds, the current yield and which companies are offering the bonds in the secondary market.
# Never concentrate on COUPON rate. It is the interest rate which you will receive on a yearly basis till maturity. However, you are investing either more or less than the issue price, hence this DOES NOT MATTER TO YOU AT ALL.
# Concentrate on YIELD rather than the coupon. Because your return on investment will be YIELD but not COUPON. YIELD and COUPON will be same if you purchased during the first issue. However, you are buying them from the secondary market. Hence, due to price variation, there will be a change in YIELD.
# Concentrate on the MATURITY date. Yield returns you will get it if you HOLD the bond till maturity. KEEP THIS IN MIND. Also, try to buy the bond as per your holding period.
# If possible try to concentrate on trade volume also. Higher the volume means higher liquidity for you. Hence, in the future, it may help you if you try to sell it in the secondary market.
Advantages of Tax-Free Bonds
# Tax Free Returns on the current yield of around 6% is not at all bad.
# Assume you are under 30% tax bracket, then holding a 6% Tax Free Bond is same as that of the holding 8.5% Bank FD. If you are under 20% tax bracket, then holding 6% tax free bond is same as that of holding 7.5% Bank FD. Same way, if you are under 10% tax bracket, then holding 6% tax free bond is the same as that of holding 6.5% FD. Hence, investing in such tax free bonds is more beneficial for those who are at a higher tax bracket.
# Best for those who are looking for yearly income from their investment.
# They are safe as the issuing companies of Public Sector Companies.
# NO TDS on yearly interest.
# If luckily the interest rate falls in future than the coupon rate you are holding, then your bond price may go up. In return, if you sell it in the secondary market, then you may earn more than what you invested.
Disadvantages of Tax-Free Bonds
# These bonds offer you the annual interest rate. Hence, not suitable for those who are looking for the accumulation of wealth rather than yearly income.
# Maturity is for long term. Hence, enter into such bonds with caution.
# Even though you can sell them in the secondary market, the successful selling depends on the number of buyers and the price you quote.
# If interest rates go up then the bonds you are holding, then the price of such bonds will decrease. Hence, if in middle you try to sell it in the secondary market, then you may get the lesser price of what you paid for buying the bond.
Considering all these options, I recommend tax-free bonds to those who are looking for safe, annual, tax-free and long term returns, then definitely you can buy and invest.
Refer our other posts related to Bonds:-
- 7.75% Government of India Savings Bonds -Should you invest?
- All about Sovereign Gold Bonds Scheme
- Tax Free Bonds-Who can invest?
- Bond-Risks associated with it