IDFC Infrastructure Bonds for Tax Saving: Calculation & Effective Returns

In this article, we cover the calculation for effective returns from IDFC Long term Infrastructure Bonds for Tax Saving. This is second part of article IDFC Long term Infrastructure Bonds for Tax Saving: Review, Analysis & Calculation for Effective Returns. Please read part I before reading this part II

Calculations for effective returns from IDFC Long term Infrastructure Bonds for Tax Saving

Now, please note that tax saving is available only for maximum of 20,000 Rs. invested in these bonds. So whether you buy bonds worth 1 Lakh or 10 Crore, you will get only a maximum tax benefit for 20,000 Rs. investment.

Second, dont get a wrong impression about maximum tax savings. The tax saving actually depends upon your tax bracket. So if you invest, say 20,000 in the IDFC Long term Infrastructure Bonds for Tax Saving, and you fall in 10% tax bracket, then the tax you save is only 10% of 20K i.e. only 2,000 Rs.
People who are in highest tax bracket of 30% will save the maximum tax i.e. 30% of 20K = 6,000 Rs.
So first check your tax bracket and follow the calculations below.

Now to check how much effectively you get by investing in these IDFC Long term Infrastructure Bonds for Tax Saving, let's take an example of a person who is in highest tax bracket of 30% and he invest 20K in these bonds which is locked for 5 long years. Assume that he sells off his bonds after 5 years

What he saves in taxes is 30% * 20K = 6,000 Rs. (one time only)
What he receives each year in form of interest payment = 8% per annum * 5 years = 40% i.e. 40% of 20K = 8,000 Rs. (over a period of 5 years)

Total Returns over a period of 5 years = 6K + 8K = 14K
Total invested amount = 20K

Returns % over a period of 5 years = 14K/20K = 70%
If we take a simple average over 5 years, returns per year = 70% / 5 years = 14%

So this appears to be a good option to invest your money as the returns are much higher (considering a simple average)
But then, the biggest problem is that your money is locked in for 5 long years. If you are fine with that and dont need that money, it is worth investing in these bonds.
However, if you have any liabilities, like a high interest loan payments to be made, say a car loan chargin you 12% per annum, then instead of investing in these bonds, it is better to pre-pay your high interest car loan. You will save in the long run.

For the case of 20% tax bracket investor, the tax saving will be 20% only. Effective return will be 20% tax saving + 40% interest income = 60%.
Over a 5 year period, it comes to just 12% (simple average). Again, check your liabilities and see if you can get rid of any outstanding loans before making any such investments.

For 10% tax bracket, I dont really see any effective gains. Total returns over 5 year period will be 50%, making it 10% annual (simple average). No point in locking your money for 5 long years for such a return. Instead, check out high interest paying Fixed deposits now available through various banks.

Even for the best case of 30% tax bracket we discussed above, one must note that over the 5 year long period, the value of your money will keep coming down due to inflation and increased cost of living. So dont live under the false impression that you will actually get the worth calculated above. Remember its for 5 long years, your money is getting blocked.
Also note that the interest you earn on these bonds is NOT tax free. Reduce that tax and again check for effective returns for 30% tax bracket:
Interst Income: 40%
After 30% tax: 40% * 0.7 = 28%
Net : 30% (Tax saving) + 28% = 58% (over 5 years)
Simple avergae annual return = 58% /5 = 11.6% only.

So make your own calculations, Invest cautiosly, and only if you just need tax saving and have no other liabilities

All Other Tax Saving Infrastructure Issues open Now:
IIFCL Infrastructure Bonds for Tax Saving - Closing 4th March 2011

L&T Infrastructure Bonds for Tax Saving - Closing 7th March 2011

PFC Infrastructure Bonds: Review - Closing on 22nd March 2011