The hidden benefit in Tax-Free Bonds
Last updated: 06 Jul, 2020 | 05:46 pm
- They are issued by a handful of PSU companies that are operated and backed by the government of India.
- These have the highest credit rating possible of AAA. Therefore, they have extremely low credit risk.
- The yields are less volatile compared to the yields of corporate bonds.
- They have very high liquidity.
But most tax-free bonds are currently trading at a Yield to maturity (YTM) of ~4.5%. Why invest in a bond at such low yield?
If you are in a high tax bracket, then you definitely must.
Let’s understand how this is beneficial for you!
Below is an example of an investment of 1 Cr in a HUDCO Tax-Free Bond vs a HDFC Bank Bond with similar maturity dates
- So your interest earned is significantly higher in the tax-free bond.
- However, given the price paid for the bond, you do make a capital loss when the bond matures.
- So you make a higher capital loss at maturity in the tax-free bond although in total you earn higher
- However, the key upside in booking a capital loss is that it can be used to offset capital gains you make on other investments across equity, debt, gold or real estate!
- This gives you an extra benefit that can be carried forward for 7 years.
- HUDCO Bonds offer nearly ₹6 lakh tax-free every year. This is an excellent option for investors in the highest tax bracket of 42.7%, as there is no other instrument with the same level of safety offering such a high yield.
- In addition to the higher amount you earn on interest received, you also can use the capital loss to offset gains made elsewhere giving you an extra post-tax benefit.