Seema, a physics teacher, caught up with her friend Reena, a chartered accountant, over the weekend. After the usual chit-chat about friends and family, the conversation shifted to money.

Reena: I’ve been working overtime in the last couple of weeks. Year-ends are always like that though. A lot of clients come for advice on last minute investment options to save taxes.

Seema: Oh yeah? The school has also been asking us to submit these details soon, if we haven’t done it already. And I have only my insurance policy to show! I remember you advised me some time back to open a PPF account. But my husband read about these tax-free bonds.

For almost the same tenure of 15-20 years as the PPF, some of them offered higher interest. So I invested in these bonds instead of the PPF.

Reena: Yes. It has been raining tax-free bond offers in the last few months and because of the high tax-free interest rates of close to 9 per cent, many of these were lapped up quickly.

Of course, like you said, both these bonds and the PPF are instruments which stretch over longer time periods, unlike say, fixed deposits.

A PPF account can, in fact, be extended in blocks of five years after the first 15-year period.

But there are a few things you must be aware of before you choose one over the other. For one, the initial investment up to ₹1-lakh will be deducted from your income for tax purposes for a PPF investment. So say you put in ₹1-lakh and you are in the 10 per cent tax bracket. Considering the tax break, it is as though you were investing only ₹90,000, but earning interest for a ₹1-lakh investment. Got it? In tax-free bonds, you don’t get this tax break. But in both options, the interest is tax-free.

Seema: Ok. The hitch with PPF is that interest rates are not constant. This year and next, we get 8.7 per cent. But it could change in the future as it will be reviewed by the government each year. So I won’t know how much I will get. If I invest in tax-free bonds, I know how much I will get throughout.

Reena: That’s there. But in the PPF, apart from the initial tax break, every year’s interest credited to your account will also earn interest from the following year. So what you could get on maturity may be more than what you actually see as the interest rate per se.

In tax-free bonds, what you see is what you get. The interest will be paid out every year or at regular intervals. It is left to you to simply spend it when it is credited to your savings account or to diligently reinvest it elsewhere.

Seema: That’s so very true! I did not think of that angle.

Reena: There is the angle of safety of investments, too, which you must not forget. PPF is considered to have a sovereign guarantee, as it is run by the government. Tax-free bonds are issued by companies. While they may have some form of government shareholding, you must still watch out for the ratings that these companies get for the bond issue. Sometimes, lower rated companies may offer higher interest to compensate for the higher risks involved. Generally, an ‘AAA’ rating is considered the safest, but it may still not be as safe as the PPF.

Seema: That’s another important differentiator. But tell me, can I pull out money invested in these instruments before they mature? We can never know what needs we will have in future, can we?

Reena: As far as the tax-free bonds go, they will be listed and traded on the stock exchanges. So if you need the funds locked into it, that’s your exit route. But liquidity may not be very high and you might find it tough to get a buyer. Besides, the interest may be tax-free, but you will be subject to capital gains tax when selling through the exchange.

For the PPF, there is an option to obtain a loan against it in the initial years, with elaborate rules on how much can be pulled out and how it should be repaid. You can also make withdrawals beginning the seventh year, but there is quite a bit of fine-print involved. In any case, whatever you pull out is also tax-free. However, keep in mind that long-term investment avenues such as this will help in building your retirement nest. So try your best to not break it.

Seema: I’ll keep in mind what you said, Reena. I have some surplus cash right now. I will perhaps open a PPF account before March 31 with it. Not only will I build a nest for my later years, but I will also benefit from lower taxes. Thanks for sharing your thoughts.

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