Home >Money >Personal Finance >Tax-free bonds are lucrative but look at yields before investing

Interest rate on most traditional instruments have been revised lower since the Reserve Bank of India’s (RBI) monetary policy on 27 March. In this scenario, tax-free bonds on stock exchanges can be a lucrative option.

State Bank of India (SBI) offers 5.7% interest rate on fixed deposits (FD) of one- to 10-year tenures. In post office saving scheme, a depositor can get 5.5% rate for one-, two- and three-year tenures, and 6.7% for a five-year FD.

An investor not only gets higher returns on tax-free bonds but also doesn’t need to pay any tax on gains. “They come with sovereign guarantee and works well for those in the tax bracket of 20% or more," said Suresh Sadagopan, founder, Ladder7 Financial Advisories, a Mumbai-based financial planning firm.

Tax-free bonds are typically long-tenured papers that government-owned companies had issued many years back, but investors can buy them on exchange from those who had subscribed to these bonds.

Some of the companies which issued tax-free bonds include National Highways Authority of India (NHAI), Housing & Urban Development Corporation Limited (HUDCO), Indian Railway Finance Corporation Limited (IRFC), Power Finance Corporation Limited (PFC), National Highways Authority of India (NHAI), NTPC Limited, REC Limited, NABARD, and India Infrastructure Finance Company Limited (IIFCL). The coupon rates on these bonds vary between 7.5% and 9.0%.

But don’t just go by the coupon rates of these bonds. An investor needs to check the yield-to-maturity (YTM) of the bonds before buying. YTM shows the total return a person will receive if he holds the bonds till maturity, which includes interest payment plus any gain (if you purchase at a discount) or loss (if you purchase at a premium). It depends on the price the investor is willing to pay for the bond.

Take the 15-year IRFC bond as an example, which was issued on 21 December 2015. The face value of the bond is 1,000 and the coupon rate is 7.53%. On the National Stock Exchange of India, the last traded price of this was 1,195. The YTM of the bond comes to 5.37%. If you were in the 30% tax bracket, this is as good as an FD fetching 7.7% rate. You can get the YTM for bonds on exchanges based on the last traded price. Alternatively, you can use calculators available on internet.

As these bonds are popular, many intermediaries and brokers also deal with these. Though commission vary with broker, typically, they charge 10-15 basis points (bps). One bps is one-hundredth of a percentage point. The minimum investment that brokers would look at is 1 lakh to 2 lakh for each transaction.

Before buying bonds in the secondary market, do keep in mind the yield to maturity and the post-tax returns.

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