These bonds, named after Section 54EC of the Income Tax Act, 1961, are issued by government-approved entities such as Power Finance Corporation Limited (PFC), Indian Railways Finance Corporation Limited (IRFC), and Rural Electrification Corporation (REC). However, with a fixed return of 5.25% and a five-year lock-in, are they the best use of your money?
If you can earn an annual return of more than 8% elsewhere – say, in a mutual fund – you may be better off paying the tax and investing the rest. Over five years, an 8% annual return on the post-tax amount could surpass the maturity value of a 54EC bond.
Mint spoke with experts to help you decide which option is right for your financial goals and risk appetite.
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What do the experts say?
Harshad Chetanwala, co-founder of Mywealthgrowth.com, explained, “Suppose I have capital gains of ₹25 lakh from a property. The entire ₹25 lakh needs to be invested in 54EC bonds within six months to claim the tax exemption. It offers a return of 5.25% over five years. Alternatively, if pay 12.5% long term capital gains tax and invest the remaining sum in a mutual fund or similar instrument yielding around 8%, the final outcome turns out to be quite close.”
“If someone can generate 9% or more through balanced advantage or multi-asset funds, the mutual fund strategy will yield a higher post-tax corpus, provided one is comfortable with the higher risk,” Chetanwala added.
Mutual funds, especially hybrid ones such as balanced advantage funds (BAFs) and multi-asset funds, can offer long-term returns exceeding 10%, but they carry market risk.
Amit Sahita, director at Fincode Advisory Services Pvt. Ltd, said, “I am always in favour of avoiding products like 54EC bonds, which optically save tax but actually end up locking up funds with very low returns over long periods. We have always advised our investors to pay the tax and then invest according to their risk profile and timeline.”
He added, “The cap for 54EC Bonds is ₹50 lakh, so extremely risk-averse investors, those who prioritise capital protection and guaranteed returns over higher growth, do end up buying them. But the usual strategy of paying tax and investing in a mix of debt and equity funds works better.”
What about liquidity?
Liquidity is another significant factor. 54EC bonds come with a five-year lock-in, while mutual funds offer easier redemption options and allow for rebalancing – a critical advantage in uncertain markets.
Ajay Vaswani, a chartered accountant and an NRI tax advisor, said, “You can pay the capital gains tax and then invest the remaining funds in more liquid and potentially higher-return instruments like mutual funds. These offer greater flexibility, and over time, could provide better returns,” he said.
He added, “If you’re in the 30% tax bracket, your post-tax return from 54EC could further fall since the interest is taxable, which is barely above inflation.” This erodes the appeal of 54EC bonds further, especially for high-net-worth individuals.”
While the math may favour mutual funds, human behaviour tells a different story. Abhishek Kumar, a Sebi-registered investment advisor and founder of SahajMoney, said, “Most individuals prioritize immediate tax savings over long-term investment growth. When people sell property, they’re often more focused on saving taxes than making investment decisions that are aligned with their financial goals.”
Ultimately, the choice between 54EC bonds and paying capital gains tax to invest elsewhere is a personal one. Factors such as your tax bracket, investment horizon, risk appetite, and portfolio composition all come into play. “If your debt portfolio is underfunded, investing in government bonds could make sense. The key is to look beyond immediate tax saving and consider long-term financial growth and portfolio balance,” Kumar said.
Final thoughts
For conservative investors or those looking to boost their fixed-income allocation, 54EC bonds can serve a purpose. But for those with a medium to long-term horizon and a willingness to take risk, paying the tax and investing in a diversified mutual fund portfolio is probably the more rewarding strategy.
“The decision shouldn’t be purely based on tax. We’ve had real-life cases where we advised clients to invest in 54EC bonds when the gains were significant. But when the gains were marginal, we suggested paying the tax and deploying the funds elsewhere for better long-term outcomes,” Chetanwala said.