Tax saving Bonds involves minimum risk factor

By SiliconIndia   |   Tuesday, October 19, 2010
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Bangalore:The Tax Saving bonds are for individuals with low risk appetite, who are looking to primarily preserve income and earn returns on the same as a secondary goal.Tax-saving bonds are issued by RBI and organizations belonging to both public and private sectors.

Tax-saving bonds are one among the important tax saving options available to individuals. Interest incomes generated by them are tax deductible and this is over and above the Rs 1 lakh tax exemption investors can avail of under section 80C of the I-T Act.

The bonds have maturity period of 10 years with a 5 year lock-in period without a buy back option from the issuing company. RBI issues tax-free 'RBI Relief Bonds' which offer 8.5 percent interest rate compounded every 6 months. The bonds are extremely safe and mature in 5 years. A special feature is that these can be pledged as securities in a bank for borrowing credit. RBI Relief Bonds can be sold to another party in the secondary equity market and this provides liquidity to the investor.

The relatively small face value of Rs 1,000, visa-via other types of bonds, provides additional liquidity as it simplifies the transferring process to a third party and provides flexibility to the investor in terms of choosing the fraction of the total bond investment to sell off. ICICI bank, India's largest private sector bank, issues tax-saving bonds 'ICICI Safety Bonds' which offer a reduction in tax liability up to Rs 16,000 per annum under Section 88 of the I-T Act. Investors have three options to choose from - 3 year bonds offering 9 percent returns two face values of Rs 5,000 and Rs 6,600, and 6.5 year bonds with face value of Rs 9,000 offering a 9 percent return.

The finance ministry has approved public issue of tax-free, secured bonds of Rs 1,000 face value by the Indian Railways Finance Corporation (IRFC) for raising Rs 3,080 crores in the financial year ending March 31, 2011. The bonds would yield interest rates in the range of 6-7.25 percent per annum, depending on the size and maturity of a tranche. IRFC bonds are a lucrative option for investors in the 30 percent tax bracket. The bonds are guaranteed by the government and therefore are as safe as bank deposits.

Return generated by the bonds are much higher than that of bank deposits and hence are superior to bank deposits. Returns of 6-7.25 percent in taxable instruments are approximately equivalent to 9-11% returns in taxable instruments for an individual in the 30 percent tax bracket. Bank FDs are currently offering 7-7.75 percent depending on maturity.

A disadvantage of tax-saving bonds is that the interest rates offered are not adjusted for inflation which, at current 10 percent level, can significantly erode the value of bond investments.

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