Fixed Income
Inflation Index Bonds Vs Bank FDs – Early redemption penalty decoded

Inflation Indexed Bonds is a welcome option for long-term conservative saver. Find out how the early redemption penalty compares with premature withdrawal penalty of bank FDs. Should you dump bank FD and go for these bonds? Can you use it for retirement planning?
 

Inflation Indexed National Savings Securities-Cumulative (IINSS-C) securities are being launched by the Reserve Bank of India (RBI) in the backdrop of announcement made in the Union Budget 2013-14 to introduce instruments that will protect savings from inflation. Interest rate on these securities would be linked to final combined Consumer Price Index [CPI (Base: 2010=100)]. Interest rate would comprise two parts - fixed rate (1.5%) and inflation rate based on CPI and the same will be compounded in the principal on half-yearly basis and paid only at the time of maturity. E.g. CPI of 11.24% in November 2013 means you can expect to get 12.74% pa assuming the inflation stays at same level. The minimum and maximum investment per annum is Rs5,000 and Rs5 lakh respectively. The tenor is fixed at 10 years.
 

Early redemption:
 

Early redemptions of IINSS-C will be allowed after one year from the date of issue for senior citizens (i.e. above 65 years of age) and three years for all others, subject to penalty charges at the rate of 50% of the last coupon payable for early redemption. Early redemptions, however, will be made only on coupon dates.
 

Hefty penalty for early redemption is a major deterrent, but bank FD too usually has premature withdrawal penalty of 1% lesser interest rate than the rate offered for the period FD was kept. The calculation of bank FD penalty will be similar to IINSS-C penalty and hence long-term saver in lower tax bracket should not overlook IINSS-C. IINSS-C is suitable for those saving for retirement with no need for regular interest payment from the product.
 

For example, if you redeem IINSS-C at the end of fourth year, you lose half the interest of the third year. For simplicity, assume 10% pa simple interest paid by IINSS-C on investment of Rs5 lakh. The interest payment is Rs50,000 pa, which means Rs2 lakh at end of four years. With 50% of last coupon as penalty, it will be Rs25,000 and hence you will effectively get Rs1.75 lakh interest after four years.
 

In case of 10 year bank FD @10% pa (simple interest assumed), you will have accrued Rs2 lakh after four years. Due to premature withdrawal, there will be penalty of 1% lesser interest rate than the rate offered for the period FD was kept. Assuming the interest rate for four years was same (10% pa), the interest calculation for four years @9% pa will be Rs1.80 lakh. It means the penalty was Rs20,000.
 

In the above example, FD fared marginally better than IINSS-C after four years. If you prolong the early redemption, IINSS-C will start looking better than bank FD as the penalty of bank FD will be onerous when you get closer to the maturity date. If the early redemption of IINSS-C was after eight years, the accrued interest would have been Rs4 lakh. With penalty of Rs25,000, you will effectively get Rs3.75 lakh interest after four years. Breaking bank FD after eight years would mean interest payment of Rs3.60 lakh (@9% pa). IINSS-C will pay more than bank FD.
 

Moreover, in reality the interest of IINSS-C can be substantially higher than FD during the time of high inflation. Conversely, the returns can go lower than FD in case of low inflation. FD rates can also go low when inflation dips and hence IINSS-C should be preferred over FD as long as you have commitment to stay long-term with the product. With inflation levels going up and down, the returns from IINSS-C will be in zigzag pattern. Scheduled commercial banks offer approximately 9% pa for 10-year FD, which is guaranteed and smooth for the full period.

User

COMMENTS

Subhas Mallik

3 years ago

Thanks for a well written article by Raj Pradhan. However, please clarify the followings:
1)whether IINSS-C will be listed in stock exchanges like the Tax-free bonds?
2)How can RBI decide independantly about senior citizen's age of 65 years contrary to that mentioned as 60 years in 2012 Finance bill?
3)Which is the best option for a senior citizen to invest Rs 5.00 lacs among the three i,e IINSS-C/Tax free bond/FD considering 10% IT bracket and tenure for 10 years?

Kid

3 years ago

Mistake in 2nd last para.

You wrote, ".....get Rs3.75 lakh interest after four years." Whereas, I believe it should read as, "...get Rs3.75 lakh interest after eight years."

Kindly check and inform accordingly.

Chandragupta Acharya

3 years ago

Interest will be taxable on accrual basis though not received in cash. This is a big drawback. With bank FD, you have the option of receiving regular interest.

Otherwise, inflation indexed bonds are good in all other respects.

REPLY

KRISHNA R M

In Reply to Chandragupta Acharya 3 years ago

Under Income Tax Act, 1961, Interest Income id taxable under the head Income from other sources. Under this head A person has the liberty to choose whether he wants to offer the interest on accrual or cash basis..!! So this per se is not a drawback.

Apoorva Raval

3 years ago

How could one can invest into it.. if you can explain that it would be of great help..

REPLY

raj

In Reply to Apoorva Raval 3 years ago

The product will be sold by agency banks and hence should be easy to invest.

raj

In Reply to Apoorva Raval 3 years ago

The product will be sold by agency banks and hence should be easy to invest.

raj

In Reply to Apoorva Raval 3 years ago

Details are awaited, but it should be available in agency banks.

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Congress, BJP, CPI, CPI (M), NCP and BSP yet to appoint PIOs under RTI Act

Association for Democratic Reforms has filed a complaint to the Central Information Commission (CIC) to take action against Congress, BJP, CPI, CPI (M), NCP and BSP

Association for Democratic Reforms (ADR), which along with right to information (RTI) activist Subhash Chandra Agrawal has been campaigning for the six national political parties to come under RTI, after having procured sensational documents under RTI Act pointing that these parties are ‘public authorities’. They are now asking the Central Information Commission (CIC) for action against these political parties since they have not abided by CIC’s 3 June 2013 verdict (CIC/SM/C/2011/001386 & 000838 dated 3 June 2013) of directing all these parties to appoint Public Information Officers (PIOs) within six weeks.
 

On 11 December 2013, ADR and Mr Agrawal filed a complaint against six national political parties, Indian National Congress (Congress), Bharatiya Janata Party (BJP), Communist Party of India (Marxist)-CPI(M), Communist Party of India (CPI), Nationalist Congress Party (NCP) and Bahujan Samaj Party (BSP).
 

Their press release stated: “Central Information Commission in its full-bench verdict dated 3 June 2013 had held that six national political parties INC, BJP, CPI, CPI(M), NCP and BSP were public authorities under the Right to Information Act, 2005. The Commission further directed the six political parties to appoint Public Information Officers (PIOs/CPIOs) within six weeks of the order, to respond to existing RTI queries within the next four weeks. The six parties have not complied with the CIC even after more than six months. By doing this political parties are defying the decision of a statutory authority. The CIC had given its decision of 3 June 2013, after several hearings of similar complaints filed by the ADR and the well-known RTI activist, Mr Agarwal. Earlier, Mr Agarwal had filed a complaint for non-compliance on 29 August 2013 after 12 weeks of the CIC decision. He also filed another complaint on 9 September 2013.”
 

It may be recalled that the CIC, in its decision had ruled that political parties should come under the ambit of RTI, considering that the Election Commission (EC) is the public authority, which plays a crucial role in bringing any political party into existence and its control over them, subsequently. It also took into account the fact that political parties are substantially funded by the government, thus making them, public authorities under Section 2 (h)(ii).
 

A full bench comprising Chief Information Commissioner Satyananda Mishra, Information Commissioners ML Sharma and Annapurna Dixit based their judgment on the following grounds: 
 

  • Political parties are registered with the Election Commission of India (ECI) under Section 29A of the Representation of People Act, 1951
  • For the purposes of elections, an association/body gets the status of a political party only on its registration with the ECI under Section 29A
  • Para 16A of the Election Symbols (Reservation & Allotment) Order, 1968, empowers the ECI to suspend or withdraw the recognition of a political party if it refuses to follow the lawful directions and instructions of the Commission or if it refuses to observe the provisions of the Model Code of Conduct
  • As per the Supreme Court judgment in Common Cause V/s Union of India (AIR 1996 SC-3081), the ECI is empowered under Article 324 of the Constitution to require the political parties to submit details of expenditure incurred by them in connection with elections
  • The ECI has directed the political parties to submit their accounts within 90 days after general elections in case of Lok Sabha and within 75 days in the case of Assembly elections
  • Under Section 29C of the RP Act, a political party is required to report to the ECI in respect of contributions received by it in excess of Rs20,000 from any person or company
  • The contributions made to the political parties are exempt from the Income Tax, both for the donor and the donee
  • Recognition of political parties is governed by the provisions of Election Symbols (Reservation and Allotment), 1968, which is an order issued by the ECI under Article 324 of the Constitution read with Rules 5 & 10 of the Conduct of Election Rules, 1961, to provide for specification, reservation & allotment of symbols and recognition of political parties and matters related thereto.)
     

Anil Bahirwal, one of the founders of ADR, said, “Non-compliance by the political parties is akin to contempt of court. Such nonconformity by these national parties can be precarious to our democracy and interest of the public at large.’’
 

Our earlier stories on this subject in Moneylife

Political parties asked to designate PIOs and Appellate Authorities within 6 weeks

 

Leading activists call for countrywide public action against amendment in RTI Act

Vociferous protests across country against political parties slipping out of RTI
 

Indian political parties fear RTI consequences; skip CIC hearing
 

Congress brags about bringing in the RTI Act but was the only party to skip the CIC hearing

 

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