Tax-Free Bonds vs. Bank Fixed Deposits - A Comparison
There are lots of investment
options available in the capital market such as Equity, bonds, Mutual Funds and
much more securities. It is very difficult to choose between the securities as
to which is the best as per the market conditions and other matters affecting
its existence and status in the market.
Tax free Bonds and Bank
Fixed Deposit are one of such options for investment of long term. The bonds
are considered as the safest security in the capital market. While FD with bank
is also safe as it is in the hands of the Banks and the Banks are governed by
the RBI so the public interest is never at stake. Let us see which of the two
securities viz. Tax free Bonds and Bank Fixed Deposit acts best for the
investor from different angles by keeping in mind the affecting factors in the
market.
The points of comparison
between Tax free Bonds and Bank Fixed Deposit are as given here under so that
it becomes easy for the investors to choose between Tax free Bonds and Bank
Fixed Deposit:
Ø Tenure: The Tenure of the Fixed Deposit is generally around 5
to 10 Years while that of the Tax Free Bonds is around 10 to 20 years. Tenure
is the lock in period. Your funds will be locked ill the completion of the
tenure. Thus if we think about the liquidity the Fixed Deposit provides early
liquidity as compared to the tax free bonds. So the people who want to
liquidate their investment in a short tenure, they can opt for the Bank Fixed
Deposit option rather than going for the Tax Free Bonds.
Ø Taxability on Return: The return on Tax Free Bond
as the name suggests is not chargeable to any tax. But the Fixed Deposit
Interest is taxable as per the applicable tax bracket. This feature provides
attractiveness to the Tax Free Bonds as compared to the Fixed Deposit with
Bank. The interest on Bank Fixed Deposit affects the tax bracket of a person
and may drag him to the higher tax bracket.
Ø Pre Tax Rate of Return: The interest rate of return
before tax is around 7.22 to 7.88% on Tax Free Bonds and around 8.5 to 9 % on
Fixed Deposits. So if there is no tax imposed on the Fixed Deposit Interest, it
is more attractive option as compared to the Tax Free Bonds.
Ø Post Tax Rate of Return: Before imposition of tax the
Fixed Deposit is an attractive option but after imposition of tax, the scenario
of attractiveness changes on a large scale. We can see that after the tax is
imposed the interest rates on Tax free Bonds are ultimately higher as it will
remain same but the interest on Fixed Deposit will reduce as follows:
o At 10.30% Tax
Bracket - 7.71% to 8.16%
o At 20.60% Tax
Bracket - 7.05% to 7.46%
o At 30.90% Tax
Bracket - 6.49% to 6.88%
Ø Liquidity Feature: The Tax free Bonds can be
easily liquidated as compared to the bank Fixed Deposit. The liquidation of
Fixed Deposit before completion of tenure attracts lots of charges and provides
the investor with reduced interest rate. While the Tax Free Bonds can be
liquidated and transferred easily. It also provides the return annually which
will help to maintain certain portion of liquidity indirectly.
Ø TDS Applicability: As the interest on the Bank
Fixed Deposit is chargeable to tax, the Bank deducts the Tax at Sources before
paying the interest to the investor. While in the case of Tax Free Bonds, the
interest is not at all taxable so the question of deducting tax at source does
not arise at all. When the Interest amount exceeds Rs. 10,000 than the Bank
will deduct tax at source on interest on Fixed Deposits.
Ø Safety: The Tax Free Bonds are generally issued by the
Government and so they are highly secured and the chances of not getting the
money back are little. While in the case of Bank Fixed Deposit, no matter how
much amount you keep it as Fixed Deposit, in case when the bank does not repay
the amount back on maturity or the bank becomes insolvent, the RBI pays the amount upto Rs. 1 Lakh if the Fixed
Deposit exceeds Rs. 1 Lakh and if he Fixed Deposit is below Rs. 1 Lakh the
insurance is upto the amount of the Fixed Deposit kept by the investor.
Insurance by RBI in case of Fixed Deposit provides great safety if the Fixed
Deposit is upto the amount of Rs. 1 Lakh but if the investment amount is higher;
the tax free bonds are smarter option as they are secured investment.
Ø Form of Investment: The Tax Free Bonds are available
in both D – Mat and Physical Format. So it becomes easy to keep it in
the D- Mat format for adopting the concept of paperless office. While the Bank
Fixed Deposit is always in the physical form and the option of keeping it in
the Dematerialized format is not available. So the investors have to take care
of the bunch of papers of Fixed Deposit till its maturity.
Ø Compounding of Return: The interest on Fixed
Deposit with Banks is compounded for given period of times as per the terms and
conditions of the Fixed Deposit. It provides more return ultimately at the end
of the tenure. While in case of Tax Free Bonds, the interest or return is paid
to the investor every year so no question of compounding of the return on Tax
Free Bonds Rise. It will attract Simple interest on the investment. So if we
consider the method of calculating return, Fixed Deposit is more attractive as
the return on t is compounded as compared to simple interest paid on the Tax
Free Bonds.
The above points of
comparison will be of great use for the investors as it shows the right picture
of both the investments. The financial advisors suggests that the Tax Free
Bonds are more smarter option as compared to the Bank Fixed Deposit as the
interest on Tax Free Bonds is Tax Free and it also provides fixed rate of
interest. Also the interest on Tax Free bond is paid to the investor annually
so the same can be re – invested if it is not required for use. The best option
for re- investing the interest of Tax free bond is to deposit it in the
recurring account. As the return on Tax Free Bonds is free of tax it does not
change the tax bracket of the tax payer and it is also of great help for the
investors with higher tax bracket.
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