Tax Free Bonds

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.

What Are Tax-Free Bonds?

Tax-free bonds 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-free bonds can be your choice.

What Are the Benefits of Investing in Tax-Free Bonds?

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.

Features of Tax-Free Bonds

The unique features of tax-free bonds are:

Tax Exemptions

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

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.

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.

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.

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.

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.

Low Risk

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

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.

Liquidity

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

How to Invest in Tax-Free Bonds?

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

Check Your Eligibility

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

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.

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.

Demat Account

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

Apply for the Bond

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

Transfer Funds

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

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.

Track your Investment

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

Get Interest Payments

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

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.

Who can Invest in Tax-Free Bonds?

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

Factors to Consider Before Buying Tax-Free Bonds

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.

How are Tax-Free Bonds and Tax-Saving Bonds Different?

Frequently Asked Questions

What are Tax-Free Bonds?

Tax-free bonds are fixed-income securities issued by government entities to raise funds. Investors can earn a fixed interest on these bonds but do not have to pay any taxes on the returns.

Can Individual Investors Invest in Tax-Free Bonds?

Yes. All investors can trade tax-free bonds on the stock exchanges.

Is it Safe to Invest in Tax-Free Bonds?

Tax-free bonds benefit investors with low-risk appetites. They offer an assured income and are backed by government organisations. Thus, they are considered a safer investment alternative.

Are Tax-Free Bonds Non-Taxable?

Yes. The returns you generate from tax-free bonds are exempted from tax as per Section 10(15) of the Income Tax Act, 1961.

How do You Redeem Tax-Free Bonds?

You can redeem tax-free bonds in two ways. The first is to sell them on the stock exchange. You will automatically receive the transaction’s proceeds in your nominated bank account in a few working days. The second way is to redeem it from the bond’s issuing company after its tenure is completed.

How About Investing in Tax-Free Bonds in India?

Investors interested in saving on taxes should invest in tax-free bonds in India.

What is the Rule of Tax-Paying if you Sell Tax-Free Bonds?

If you sell tax-free bonds within 12 months, you must pay taxes based on your income tax slab. But, if you hold them for over a year, you pay taxes at 10% without indexation or 20% with the benefit of indexation.

What Bond Types are Non-Taxable?

The bonds issued by the local and state governments, like municipal bonds, are non-taxable.