rating and the interest received is tax-free.
While the interest offered on tax-free bonds is similar to that on five-year bank deposits, the bonds carry an advantage because of tax exemption on the interest earned. While post-tax returns on a bank fixed deposit range between 6 and 7%, tax-free bonds give annual returns between 8.5 and 9%.
However, bank fixed deposits score over tax-free bonds in terms of liquidity as these bonds have a longer maturity and are not easy to sell in the secondary market.
All tax-free bonds are backed by the government. So, the credit risk (risk of non-repayment) is very low. While HUDCO is rated AA+ by CARE Ratings, NHB is rated AAA by Crisil, CARE and ICRA. For most tax-free bonds, the allotment is on first-come, first-serve basis.
The interest on these bonds is paid annually, credited directly to the investor’s bank account. The annual interest payout is a good option, especially for those with a steady post-retirement income.
Financial planners say long-duration bonds reduce re-investment risk and, as interest rates may come down in the long term, it is wise to lock in the high rates these tax-free bonds are offering. For investors in higher tax brackets, these bonds are an attractive option as they can significantly lower the tax outgo.
Retail investors can even book profits by selling these bonds, but will have to pay short-term capital gains tax. The proceeds from the sale will be taxed as normal income, and long-term capital gains will be taxed at 10%. The bonds must be held for at least 12 months for the profits to be treated as long-term gains. Moreover, long-term capital gains from these bonds are not eligible for indexation benefit.
Analysts say investors should look at the size of the issue as the bigger the amount, the higher is the probability of good volumes after listing. Once the issue is listed, investors can sell these bonds on stock exchanges or even buy more of them.