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Tax Free Bonds Or Fixed Deposits–Which One Offers Better Returns In Long Run

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Whenever we plan to invest our money a lot of options comes to our mind like bank fixed deposits, company fixed deposits, mutual funds, shares, bonds etc.. To choose one out of all is little difficult for us as an investor, as we want to invest in some safe investment scheme but where to invest to get the maximum return is not known to us. Looking at the current market condition everybody wants security for there hard earned money which make them stay away from equity investment and look for some other investment avenues to ensure security.

ALSO READ : What Is The Difference Between Tax Free Bonds & Long Term Infrastructure Bonds?

Most of the people today either keep there money in saving bank account or in a bank fixed deposit for complete security. Keeping money into fixed deposit will attract tax liability on your interest income, so is there any investment scheme which can offer the benefit of safety plus tax free income. So to have a clear picture, here we are comparing two investment options which offers complete safety on investment i.e Tax Free Bonds Vs Fixed Deposits.

    • Fixed Deposit : Investors can either visit the bank or create or dissolve FD’s online.
    • Tax Free Bonds : Investors can purchase or sell tax free bonds through stock exchange.

    • Fixed Deposit : pre-mature withdrawal from fixed deposit attracts penalty.
    • Tax Free Bonds : investor can purchase or sale tax free bonds anytime without any penalty like share trading.

    • Fixed Deposit : Interest earned from fixed deposit gets add to the annual income of the investor and taxed according to tax slab.
    • Tax Free Bonds : Interest earned from tax free bonds is tax free.

    • Fixed Deposit : Interest rates remain fixed during the tenure of investment.
    • Tax Free Bonds : With Interest rates going down, bond prices will go up.

    • Fixed Deposit : There is no additional tax on maturity of fixed deposit.
    • Tax Free Bonds : Investor has to pay capital gain tax on selling the bonds in secondary market at gain.Tax Free Bonds : With Interest rates going down, bond prices will go up.

    • Fixed Deposit : Investor can anytime visit the bank to get a FD done.
    • Tax Free Bonds : Tax free bonds are not available to invest all year long.

Tax Free Bonds Or Fixed Deposits

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ALSO READ : Know About The Risks Associated With Bonds And Other Fixed Income Sources

Tax free bonds are secured and issued by public sector undertakings (PSUs). Some of the public sector companies having AAA or AA+ rating and issuing tax free bonds are NHAI / PFC / IRFC / HUDCO / REC.

Lets take an example to understand how your investment will grow in both of these investment avenues i.e tax free bonds vs fixed deposits:-

 

Tax Free Bonds

Fixed Deposit

Principal Amount Rs 500,000 Rs 500,000
Interest Rate 8% p.a. 9% p.a. (Approx. 6.45% post Tax)
Gross Interest Income Rs 40,000 Rs 45,000
Net Interest Income (Post Tax) Rs 40,000 Rs 32,250

So here the effective rate will make a big difference in the return on income. Here if you choose to invest Rs 5 lakh in fixed deposit @ 9% interest rate you will end up paying tax on the interest income and you will effectively earn Rs 32,250 interest on your investment. Whereas if you invest similar amount in tax free bonds you will not have to pay tax on your interest income and you will get better return on your investment i.e Rs 40,000.

How To Invest In Tax Free Bonds?

You can find these bonds listed on the stock exchange (BSE and NSE) in the equity segment. These are placed in equity segment to offer the flexibility of buying and selling these bonds like shares. So don’t get confused because of its placement, these are bonds not equities.

You can buy or sell these bonds like you trade in shares, using your demat account you can place order with your broker.

Some Important Points

  • Tax Free Bonds are good for those investors who fall under the highest tax slab i.e 30%.
  • Tax Free Bonds will help you generate better returns if you reinvest the annual interest earned regularly.
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