RBI Inflation Bonds now open till 31st March 2014

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Sensing the poor response, Inflation index bond got an extension from RBI.  New deadline is March 31st 2014. Earlier deadline was 31st Dec 2013.
Here is my take on what Inflation bonds or Inflation Indexed National Savings Securities, are and who should invest.

What are Inflation Indexed Bonds?
Unlike other bonds where interest rate is fixed for entire tenure, here government will pay additional 1.5% interest over and above the inflation rate. Inflation rate will reset every six months and is based on Consumer price Index.  For e.g. If the CPI is 10% for the entire year, the final interest is 11.5%. It will be compounded half yearly.

Basic terms and conditions:

Minimum amount:  Rs. 5000
Maximum amount:  Rs. 5 Lac.
Tenure:  10 year.
Premature withdrawal:
Senior citizen can withdraw after 1 year, for rest it is 3 year.
Penalty on premature withdrawal:   Half of the last payable coupon. For eg: if the last coupon is Rs. 1000, penalty will be Rs. 500.
Maturity: Principal and interest earned.

 Additional 1.5% interest over and above inflation makes it interesting; however  no tax exemption while investing and tax deduction during maturity makes post tax return very low.
Interest earned is taxable: for the people who are in high tax bracket, the effective return is close to 8%.


Amount
Interest
Interest
earned
10.30% tax
20.6% tax
30.90% tax
100000
11.50%
11500
10.31%
9.10%
7.90%

 Interest will not be paid regularly: people who are looking for regular income should stay away from inflation bond.

There is also provision of pledging bonds in lieu of loan , however already instruments like PPF are available which not only offers good post tax returns and linked to inflation but also offers loan facility.
Only those who are in lower tax brackets and can park their money for longer tenure can go for inflation bonds , they are available at nationalized banks, ICICIC, HDFC and Axis bank.  It is unattractive for rest.

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