Creating wealth through tax-free bonds

Dec 09 2013, 12:59 IST
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If you have an investment amount that you will not need over the next 10 years or so, it makes good  sense to invest in tax-free bonds If you have an investment amount that you will not need over the next 10 years or so, it makes good sense to invest in tax-free bonds
SummaryIf you have an investment amount that you will not need over the next 10 years or so, it makes good sense to invest in tax-free bonds

cent then it will be taxed at that rate. Therefore a pre-tax equivalent for an investor in the highest tax bracket on a bond offering 8.66 per cent will stand at 12.37 per cent whereas that on 9.01 per cent bond will stand at 12.87 per cent. Such a return on AAA and AA+ rated instruments backed by government is a rarity.

Alternatively, a post-tax return on a 9 per cent FD will be 6.3 per cent (at the 30 per cent marginal tax rate) whereas the bond offers you up to 9.01 per cent tax free. So there is a clear gap in the income generation from the two options.

If you invest Rs 10 lakh in a 9.01 per cent bond (where you reinvest the interest income in an instrument – equity etc--that also grows at the same rate) then in a period of 10 years your capital would grow to Rs 23.69 lakh. However, if the same amount is invested in a FD offering 6.3 per cent post tax then your capital grows to only Rs 18.4 lakh. So the difference in your wealth creation amounts to Rs 5.27 lakh in a period of 10 years on an investment of Rs 10 lakh.

Better than other investment options

Experts in the investment field say that the bonds offering such high rates have thrown up an opportunity for wealth creation which rarely come up and would not be there for long.

“It should not just be looked as an investment option but as a wealth creation tool as it is comparable to a taxable instrument offering up to 13-14 per cent return. These bonds can also generate capital gains along with the interest income,”said Bajaj.

Over the last few years the return on real estate has gone down and even gold has not been able to duplicate the returns it generated between 2005 and 2011. Experts also feel that gold generally hedges against inflation and therefore the long term return generation may remain similar to the inflation.

Why you should take it now?

If you have a surplus or investment amount that you will not need over the next ten years or so then it makes a good case to invest. With GSec yields being volatile and currently trading at levels of 8.7, there may be a possibility that the bonds that come up for subscription later may not carry such high coupon rates unless the

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