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Last month the government bit the bullet and slashed interest rates on popular small saving schemes like Senior Citizen Savings Schemes (SCSS) and Public Provident Fund (PPF). Millions of Indians will earn less from their small saving schemes as the interest rates were lowered by between 0.7 to 1.4 percent.

Investors in PPF and Sukanya Samridhi Scheme will be particularly hard hit as the lower rates will be applicable not only on new investment but also on the accumulated balance. Fortunately for investments in SCSS, NSC and KVP the new rates will be applicable only for investments made after 1 April 2020 and not on accumulated balance.

Small savings schemes see sharp cut for the quarter:

*Average CPI over past one year was 4.4% 

Why were the rates reduced?

Theoretically, since 2016, the interest rates of the government’s small saving schemes were to be re-set based on the yields of government securities with equal maturity periods with some spread on the scheme. Yet in practice, the Government kept them untouched. But RBI’s recent 0.75% cut in the repo rate (the rate at which RBI lends to banks) acted as the trigger.

Every cloud has a silver lining

Presently, the interest rates on Small Saving Schemes and FDs are reducing. And the corporate debt market has also given investors jitters with delays, defaults and winding up of schemes. If you are looking for a safe haven with reasonable returns, RBI Savings Bonds are one of the safest investment options.

These bonds are issued by RBI on behalf of the Government of India. They are more attractive than many fixed-income options. Most banks are currently offering around 6 to 6.5% for a deposit with tenure of 7 years. Known as 7.75% Savings (Taxable) Bonds, 2018 or RBI savings bonds in general, the bonds have tenure of seven years and offer cumulative and non-cumulative options.

If you are looking for a periodic income then the non-cumulative option, with its appealing interest rate and half-yearly interest payments, is a good choice. These bonds can be considered after you have exhausted your Section 80C investment limit.

Interest rate

The rate of interest of the bond is 7.75 per cent per annum. The frequency of interest payment is either half-yearly or cumulative. With the cumulative option, the interest will be paid only on maturity. 

Taxation of interest

Investments in these bonds are not eligible for tax benefit under section 80C of the Income Tax Act. The interest income is also taxable as per the investor’s income tax slab rate as with interest from bank FDs. For an investor in the 30% slab rate, the post-tax return drops from 7.75% to 5.42%.

A 10% TDS will be deducted at the time of interest payment if the total interest income exceeds ₹40,000 in a year.

Premature surrender

Premature encashment of the Bonds is only allowed for individual investors who are senior citizens. For the investors in the age bracket of 60-70 years, 70-80 years and above 80 years, the lock-in period is 6,5 and 4 years respectively.

However, 50 percent of the interest due and payable for the last six months of the holding period will be recovered for both Cumulative and Non-cumulative bonds.

Transfer of bonds

The Bonds are not transferable. And they are not tradable in the Secondary market. Also, they are not eligible as collateral for loans from any financial institution.

Individuals and Hindu Undivided Families may purchase these bonds with a minimum investment of ₹1,000 and with no upper limits. NRIs, however, are illegible for making investments in these Bonds.

You should invest in these bonds only if you can lock-in your investment for 7 years. Even though the lock-in condition is relaxed for senior citizens; the penalty for pre-mature withdrawal after the lock-in period is 50% of the interest due and payable for the last six months of the holding period.

Though the interest rate offered is high, the post-tax returns are lower than what debt funds offer. Investors should note that debt funds held for longer than three years are taxed at 20% and investors are also given the benefit of indexation. 

Debt funds are taxed at 20% on Long Term Capital Gains and enjoy an additional indexation benefit. We have assumed a CPI of 3%. The assumed tax rate for RBI Bonds and FDs is 30%.

Should you buy?

If you are a risk averse investor, you should consider these bonds only for that portion of your portfolio that can be locked away for seven years as the principal amount cannot be accessed during this period.

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