Bank FD or Infrastructure bonds

Some people ask the question whether to go for Bank FD or Infrastructure bonds. Really there is no need for comparison of Bank FD with Infrastructure bonds.

The reason is simple: The amount of investment which qualifies for Sec 80 rebate is normally Rs 1,00,000 (includes PF, PPF, ELSS i.e. tax saving mutual fund, NSC, 5 year bank FD etc). If you plan to invest only upto Rs 1,00,000, just go for the investment which gives you better return. So in that case, if SBI FD is offering 9.25%, it is better than an infrastructure bond offering 8.7%. Both have a lock in period of 5 years. The interest from both is taxable. Whichever offers better rate of interest, go for it. The bank FD is compounded quarterly which is an additional benefit.

The only advantage infrastructure bonds have over bank FDs is when you plan to invest more than Rs. 1,00,000 in the financial year. The infrastructure bonds provide you tax saving on Rs 20,000 over and above the 1,00,000 limit. So, if you make a total investment of Rs 1,20,000 including at least 20,000 in infrastructure bonds, you will get tax benefit on complete 1,20,000. But if your investments do not include infrastructure bonds, you will get tax rebate only on 1,00,000.

Example 1:
Ram makes the following investments:
1. PF  - Rs 40,000 (Employee contribution only)
2. PPF - Rs 20,000
3. Tax saving mutual fund - Rs 40,000
4. NSC - Rs 20,000
Total = Rs 1,20,000.
However, all these instruments come under the 1,00,000 limit, so Ram will get tax benefit on Rs 1,00,000 under section 80.

Example 2:
Shyam makes the following investments:
1. PF  - Rs 40,000 (Employee contribution only)
2. PPF - Rs 20,000
3. Tax saving mutual fund - Rs 20,000
4. 5 year bank FD - Rs 30,000
5. Infrastructure bonds - Rs 20,000
Total = Rs 1,30,000.
The first 4 instruments come under the 1,00,000 limit, so Shyam will get tax benefit on Rs 1,00,000 for first 4 investments + Rs 20,000 benefit for infrastructure bonds. So he will get tax benefit on a total of Rs 1,20,000.

Another point to note is that the maximum benefit above 1,00,000 with infrastructure bonds can be only upto Rs 20,000. So if you have already invested 1,00,000 in other instruments and your purpose is only tax-saving, then you should only invest a maximum of Rs 20,000 in infrastructure bonds.

Should you invest in Tax-saving Infrastructure bonds

First of all, a word of caution about the "realized" return the companies or agents tell you. Most of them exaggerate the returns because they assume that you fall in 30% tax bracket when you are investing and you fall in 0% tax bracket when you receive the interest and so they don't factor in the tax on annual interest received. Obviously if you are in 30% tax bracket this year, it is highly unlikely that you will be in 0% tax bracket next year.

Let's look at the real "realized" returns. We will consider that if you are in 10% income tax bracket today, you will be in the same tax bracket in the coming years. The real returns are higher than the interest rates because you save tax under section 80 CCF on investments upto Rs 20,000 in infrastructure bonds.

Here is a list of some of the current infrastructure bonds in market (2012 Infrastructure bonds), which can help you save tax for the current FY 2011-12. (Last date mentioned are for current tranches)

http://www.idfc.com/infrastructure_bond/scheme_features.htm (Last date: Feb 25, 2012)

http://www.ltinfrabond.com/index.aspx (Last date: Feb 11, 2012)

http://recindia.nic.in/infra.html (Last date: Feb 10, 2012)

Let's look at the real returns from the IDFC bonds.

This is the return table IDFC has provided (for investments upto Rs 20,000):

This is the real "realized" return (for investments upto Rs 20,000):

As we can see, the returns are not as high as claimed by IDFC and some of the advisors/agents. However, the real returns are still good compared to several other investment options.

Couple of points to note are:

1. infrastructure bonds provide the tax exemption over and above the 1 lakh limit which other instruments like PF, PPF, NSC etc provide in Sec 80.

2. It is better to use the buyback option provided at the end of 5 years compared to holding the bonds till maturity.

Though we took the specific example of IDFC bonds, but the same is applicable for infrastructure bonds by L&T and REC as well.