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Tax-free bonds need not necessarily mean higher returns. These bonds are basically issued for long-term; for an investment horizon of 10 to 15 years. With such a long tenure; investors are given sweeteners like tax exemption for the interest earned on these bonds and listing on the stock exchanges for keeping open the liquidity window. These bonds, however, do not offer any benefit of tax-savings at the time of investment.
In the current financial year, there have been eight tax-free bond issues. The aggregate amount of bonds budgeted for FY 2012-13 was over Rs 60,000 crore.
Investors are attracted to all / any investments which are tagged as 'Tax-free'; and with the dearth of options in this domain; these bonds have been many an investor's favourite. Senior citizens, too, are equally attracted to these bonds and have diversified their debt portfolio into these bonds. The fact that these bonds are generally issued by government backed entities helps reduce the risk of default and adds to their credit rating.
The bonds also offer an annual interest payout option for the bonds which makes it more appealing for the senior investors. As they are tax-free; even TDS is not applicable. The average rate of interest offered by bonds issued during this financial year has been approximately 7.4 - 7.9 per cent for tenures ranging from 10 years to 15 years. A low minimum investment also helps the small investors to take advantage of these bonds.
For investors looking to exit from these bonds before its maturity through the exchange platform; any capital gains from the sale would be taxable. Sale within one year would attract short-term capital gains as per slab rates or else long-term capital gains would be payable at 20 per cent with indexation.
With additional options now available for investments in the debt sector for senior citizens, it has led them to the problem of choice overload. The situation is similar to what if faced by people who prefer going for a thali meal rather than a-la-carte meal especially on weekends and when with family and friends. The thali option seems good as it enables focussing on eating and enjoying what is available while eliminating the problem of selecting the appropriate food item from the multiple options in the menu. Research has shown that having too many choices can not only make decision-making difficult, but can also result in bad decisions.
Senior citizens, in my opinion, should be grappling with a similar problem right now, in the context of these tax-free infrastructure bonds. Currently, alternative and traditional investment options like the Senior Citizen Saving Scheme are offering a 9.5 per cent interest; Post Office Monthly Income Plan offers 8.5 per cent interest and most Bank FDs offer 9.5 per cent p.a. for senior citizens.
None of these options have tenure longer than five years as compared to the 10 / 15 year lock-in with the tax-free bonds. It has been observed that senior citizens typically prefer a 'buy-and-hold' strategy especially when it comes to their debt investments. In other words, although these bonds may offer a liquidity window via the stock exchanges; it would require maintenance of a demat account, which may not find favour with every senior citizen.
Should a senior citizen who is looking for safety and fixed returns on his investment invest in these tax-free bonds? The answer to this question can be traced to a very simple concept in investments called post-tax yield. The current tax rates applicable to senior citizens are 10 per cent for income above Rs 2.5 lakh and below Rs 5 lakh; 20 per cent for income below 10 lakhs and 30 per cent for others.
For illustration purposes, let us assume that a bank FD as an alternative to the bonds. A senior citizen who is liable to pay tax of 10 per cent on his income would stand to gain a post-tax yield of 8.55 per cent on the bank FD vis-a-vis a 7.6 per cent yield on the tax-free bonds. As the interest on these bonds is tax-exempt; keeping in mind the taxes saved on the interest earned, the post-tax yield will be approximately 8.4 per cent. It may be observed that for investors in this tax-slab, the bank FD still proves to be a better investment option than the bonds, as it gives a higher post-tax yield and also grants better liquidity to the investor. Not only will the investor be able to access the FD money earlier, it will also help him/ her to lap up better yield investments that might come his way when the interest-rate cycle turns next.
The above illustration cannot be considered all conclusive as other investment options like co-operative bank FDs, company FDs, debt mutual funds have not been compared and evaluated against the bonds. At the time this article is being written, there are interest-rate sensitive debt funds which have yielded 11 per cent+ returns over the last one year.
To conclude, one thing that every senior citizen investor needs to keep in mind is that the problem of choice can be sorted only by evaluating the choices properly, wherever necessary, with professional help too. Merely 'tax-free' status should not result in compulsory investments.
The writer is a certified financial planner
