Should you invest in IREDA Tax-Free Bonds?

Indian Renewable Energy Development Agency (IREDA) is coming out with a Tax-free bonds issue. The issue opens on January 8, 2015 and closes on January 22, 2015. The issue size is Rs 1,716 crores. Before IREDA, NTPC, PFC , REC , IRFC  and NHAI have already come out with tax-free bonds issue this fiscal.

IREDA tax-free bond issue is the first in this calendar year. IREDA had the permission to issue tax-free bonds to the extent of Rs 2,000 crores in FY2016. The company has already raised Rs 284 crores through private placement.

In this post, I shall focus only on the factual information about these IREDA tax-free bonds. Everything else remains the same. You can refer to my posts on NTPC, PFC , REC and IRFC tax-free bonds for detailed rationale.

IREDA Tax-Free Bonds Issue: Salient Features

IREDA Tax-Free Bonds Interest Rate

Points to Note about IREDA Tax-Free Bonds

1. Only the interest earned is exempt from tax.
2. There is no tax exemption under Section 80C of the Income Tax Act on the investment amount.
3. Retail investors can only invest up to Rs 10 lacs (no more than 1000 bonds) in these bonds.
4. If you purchase more than 1000 bonds, you will be classified as High Net worth Individual and will be eligible for a lower interest rate. In fact, if you hold more than 1000 bonds at the interest record date, you will be considered a HNI and get a lower interest rate (7.43% instead of 7.68% for 20 year bond).
5. Interest shall be paid annually.
6. NRIs are not permitted to invest in IREDA tax-free bonds.
7. If you sell these bonds within 1 year, capital gains will be taxed as per your income tax slab.
8. If you sell these bonds after 1 year, capital gains will be taxed at 10%. There is no benefit of indexation for these bonds. For more on taxation of tax-free bonds, refer to this post.
9. These bonds will be listed on BSE. However, you can expect liquidity to be low. Hence, exit in the secondary market won’t be as easy.
10. The IREDA is promoted by the Government of India. So, I wouldn’t worry about credit risk.

Must Read: All you need to know about Tax-Free Bonds

Should you invest in IREDA Tax-free Bonds?

These bonds are long tenor bonds and exit from these bonds won’t be easy. The interest is exempt from tax.

The tenor is 10, 15 and 20 years. Investors looking to invest for such long horizon may find better options in equity mutual funds.

Since there is regular interest payout, you don’t get benefit of compounding in these bonds. So, these bonds are not suited for long term wealth creation. Hence, if you do not seek regular income, then these bonds are not for you.

Investors in the 10% tax bracket do not have much to gain by investing in these bonds. You can create FDs for 7.5-8% easily without any lock-in period. If you consider 50 basis points of interest more important than locking your money for 10-20 years, then you can go for these bonds. Personally, I wouldn’t apply if I were in 10% tax-bracket.

Those in 20% or 30% tax brackets and seeking regular income can think about investing in these tax-free bonds. Exit in the secondary market may not be as easy or at an unfavorable price. So, be prepared to hold the bonds till maturity if you are planning to invest.

Do consider the following before making the final decision.

Retirees and Senior Citizens can get 9.3% p.a. in senior citizen savings scheme (SCSS). Even though the interest on SCSS is taxable, you get tax benefit on the investment amount under Section 80C of the Income Tax Act. Thus, the effective yield is much higher, especially if you are taking full tax benefits.

There is no tax benefit on investment amount under Section 80C IREDA tax-free bonds.

The same argument can also be extended to 5-year tax saving fixed deposits.

For instance, if you invest in a 5-year tax saving FD that offers 8% per annum, the post-tax yield  (effective yield) shall be 9.89% (10% tax bracket), 12.08% (20% tax bracket) and14.68% (30% tax bracket).This is under the assumption you get full tax benefit for investment in such FD under Section 80C. Though tax-free bonds and tax-saving FDs are not strictly comparable, I hope you get the idea.

What do you plan to do?