REC tax-free bonds are open today for subscription. Should you invest in them? Before you make up your mind, do a quick math to know where the returns offered by REC stand compared with fixed deposits.
What are tax-free bonds?
Tax-free bonds are non-convertible debentures that offer interest income that is free of tax. There is no tax deduction for the principal amount that you invest. This is, therefore, not to be confused with tax-saving bonds such as infrastructure funds. The government approves only few institutions such as NHAI , Power Finance Corporation, Indian Railways Finance Corporation or Rural Electrification Corporation (REC) to issue tax-free bonds.
Tax-free bonds are normally bought only through demat account. But REC has offered investors the option of applying in both physical and demat form. REC bonds have an annual interest payout of 7.72 per cent (for retail investors and HUFs up to Rs 10 lakh) for 10 years and 7.88 per cent for 15 years. The interest rate is lower by 0.5 percentage points for other categories of investors. There is no cumulative option available in tax-free bonds. Interest is paid out every year on December 1.
The bonds will be listed on the stock exchanges and can be sold before maturity if they are in demat. But capital gains tax will be applicable in such a case.
How does the rate fare
Since the bonds have a fixed interest payout option, you will have to compare it with safe fixed deposits of banks. Currently, a 10-year bank deposit offers a maximum of 8.75 per cent. Post tax, at the 30 per cent and 20 per cent bracket, the returns are lower than what is offered by REC for 10 years (see table). That means, except for those in the 10 per cent tax bracket, REC bond is suitable for the rest. This is the case even if you compare the bond rate with a 5-year bank FD.
The bond is therefore suitable for those in the high tax bracket and for those looking for a regular income stream.
|10-year bank FD of 8.75%||5 -year bank FD of 9.5%||10-year REC of 7.72%|
|Post-tax return (%)||Post tax return(%)||Post tax return(%)|
|Tax @ 30%||6.12||6.65||7.72|
|Tax @ 20%||7.00||7.60||7.72|
|Tax @ 10%||7.87||8.55||7.72|
The offer is open from December 3-10 but can be pre-closed within three days of issue.
About the company
REC is a public sector company that finances rural electrification projects. Much of its loan book are secure in nature. It is also backed by the government. Its credit rating of AAA suggests high credit quality in terms of servicing its debt.
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