Tax-Free Bonds: Features, Benefits, Eligibility & How to Invest

Government bodies issue tax-free bonds to raise funds for a specific purpose. These bodies include municipal corporations, government enterprises, public sector undertakings, and other infrastructure companies. You can invest in tax-free bonds to earn a pre-fixed, tax-exempted interest every year.

Tax free bonds in India are a relatively safer investment option. Government organisations back them and allow you to save on taxes. Thus, if you want an investment tool to maximise your returns and enjoy tax-saving benefits, tax saving bonds can be your choice.

Here are some tax free bonds benefits that you should be aware of:

1. Assured Income
   With tax-free government bonds, you earn an assured interest every year. Thus, the investment is ideal for investors desiring a steady cash flow.
2. Easy Trade
   You can easily trade tax free bonds on stock market exchanges and benefit from market appreciation.
3. Safety
   The risk of default is lesser as government bodies back these bonds.
4. Higher Profit for Higher Tax Bracket
   The interest earned on tax-free bonds is not taxable. So, those belonging to the 30 per cent or above tax bracket can significantly benefit from investing in them.

The unique features of tax-free bonds are:

1. Tax Exemptions

Interest is earned semi-annually or annually on these bonds for tax exemption. Moreover, this interest is free from taxation.

2. Issued by Government Organisations

Government organisations like the National Highway Authority of India (NHAI), Indian Infrastructure Finance Company Limited (IIFCL), National Housing Bank (NHB), etc., issue tax-free bonds.

3. Long-term Investment

Generally, the fixed maturity period for these bonds ranges between 10 and 15 years, making them an ideal choice for long-term investment.

4. Fixed Interest Rates

Tax-free bonds’ interest rates are fixed. They are comparatively higher than regular fixed-income instruments, ranging from 5.50% to 7.50% per annum.

5. Diversification

Investors diversify their portfolios when they invest in tax-free bonds. The risk is reduced as all funds are not allocated to a single asset class.

6. Easy to Buy and Sell

Tax-free bonds are listed on the stock exchange, allowing investors to buy and sell them easily as they desire.

7. Low Risk

Tax-free bonds are issued and backed by reputed government organisations. Thus, they are considered low-risk investments.

8. No Maximum Investment Limit

There is no maximum investment limit for tax-free bonds. This means you can invest more for higher returns and more tax benefits.

9. Liquidity

Since they have lock-in periods, tax-free bonds are less liquid than mutual funds.

The easy step-by-step process to invest in tax-free bonds is as follows:

1. Check Your Eligibility

There are specific conditions and eligibility criteria to start investing in these bonds. Make sure you fulfill each of those.

2. Select a Reliable Financial Institution

Identify a trusted and renowned financial institution to help you with the investment. Your options include stockbrokers, mutual fund houses, and banks.

3. Research Tax-Free Bonds

Study the details of the different tax-free bonds offered in the market. Check the tenor, interest rate, issuer’s background, credit rating, etc.

4. Demat Account

Open a Demat account with your chosen financial institution to manage the bonds electronically.

5. Apply for the Bond

After successfully opening a Demat account, you can apply for the bond online or offline.

6. Transfer Funds

Next, transfer the required investment amount from your bank account to your Demat account.

7. Wait for Allotment

The issuer will allot the funds to you in a few days. You will receive a physical bond certificate or a confirmation email.

8. Track Your Investment

Check your Demat account regularly to monitor the performance of your tax-free investment.

9. Get Interest Payments

You will receive interest payments in your Demat account semi-annually or annually on your tax-free bonds.

10. Hold the Bond Until Maturity

Tax-free bonds have a maturity period. Stay invested until maturity to earn significant returns and redeem the principal amount.

Tax-free bonds are ideal for investors with low-risk appetites and high net-worth individuals who want a steady cash flow. Those who can invest in tax-free bonds include the following:

1. Partnership firms, cooperative banks, limited liability partnerships (LLP), trusts, corporates, regional rural banks, and other authorised entities
2. Retail individual investors, including Non-Resident Indians (NRIs) and members of Hindu Undivided Family (HUF)
3. Qualified Institutional Buyers as defined under the Securities and Exchange Board of India (SEBI) Guidelines, 2000
4. High net-worth individuals with a low-risk appetite and investment budget of up to Rs. 10 lakhs

A few things you should know before investing in tax-free bonds are as follows:

Determine your Investment Goals

Understand your investment goals, such as liquidity, protecting capital, or earning tax-free income. Then, determine how much and for how long you can invest.

Research Tax-Free Bonds

Gain knowledge about the different tax-free bonds available on the stock market exchange, including municipal bonds and government bonds. Compare credit ratings, interest rates, and other crucial details to ensure they align with your investment goals.

Choose a Broker

Identify and register with a renowned broker to buy and sell tax-free bonds. You can choose between a traditional or an online broker depending on your preference.

Open a Brokerage Account

Fill out the required application forms to open a Demat and trading account with the chosen stockbroker.

Purchase the Bonds

After selecting a tax-free bond, determine the number of bonds you want to buy. Complete the transaction to apply for them through your broker.

Know the Risks

Learn about the risks associated with tax-free bonds. These include market risk, credit risk, and interest rate risk. Consult a financial advisor in case of any ambiguity.