Tax-Free Bonds vs. Bank Fixed Deposits – A Comparison

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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