Tax-Free Bonds

One of the least appealing things about investing in particular financial instruments is seeing your hard-earned money go towards paying taxes. However, investment in tax-free bonds allows you to earn interest yearly without applicable taxes. Here’s everything you need to know about tax-free bonds in detail. 

What are tax-free bonds?

Tax-free bonds are debt instruments issued by the Indian government or its authorised entities, such as public sector undertakings (PSUs) and infrastructure companies. These bonds offer tax-free interest income to investors, which means the interest earned on such bonds is not subject to income tax in India.

What are the common types of tax-free bonds?

In India, tax-free bonds are typically issued by government-backed entities such as public sector undertakings (PSUs), infrastructure companies, and other government organisations. Listed below are some common types of tax-free bonds in India.

1.    Infrastructure Bonds: These are issued by infrastructure companies and are used to finance projects such as roads, airports, and power plants.

2.    Housing Bonds: These bonds are issued by government entities such as the National Housing Bank and are used to finance affordable housing projects.

3.    Power Bonds: These bonds are issued by power generation companies and are used to finance the expansion and maintenance of power plants.

4.    Railway Bonds: Issued by the Indian Railways, these bonds are used to finance the expansion and modernisation of the railway network.

5.    Public Sector Unit Bonds: Public sector unit (PSU) bonds are issued by government-owned companies such as NHAI, HUDCO, NTPC, PFC, REC, and others. These bonds are used to finance infrastructure, power, and housing projects.
 

How to invest in tax-free bonds?

1.    Know the available bonds: Check the list of available tax-free bonds in the primary and secondary markets, considering factors such as coupon rate, credit rating, maturity period, and issuer details.

2.    Open a Demat Account: You must open a demat account with a Depository Participant (DP). This will hold the bonds in electronic form.

3.    Place the bid: Once you have identified the bond you wish to invest in, you can bid through your broker or online trading platform during issuance. The bidding process opens for a few days, and the allotment is done on a first-come, first-served basis.

4.    Payment: After allotment, you must pay for the bonds online or through a cheque/DD.

5.    Trading: Once the bonds are credited to your demat account, you can trade them in the secondary market through your broker or online trading platform.
 

How to redeem tax-free bonds?

Investors can redeem tax-free bonds at the time of maturity. Typically, these bonds have a fixed term of 10 to 20 years. They can be traded in the secondary market like stocks. Capital gains from selling the bonds are subject to capital gains tax under Section 112. 

The capital earned from selling bonds before completing one year is taxable at their income tax slab rate. If sold after a year, they will attract long-term capital gains tax at 10%, without the benefit of indexation.

Features of tax-free bonds

Some of the features of tax-free bonds in India are as follows. 

1.    Tax-free Income: The interest earned on these bonds is exempted from income tax, making them a popular investment option for investors looking to generate tax-free income.

2.    Fixed Interest Rate: Tax-free bonds' interest rates are fixed throughout the bond’s tenure, providing a predictable income stream.

3.    Long Maturity Period: Tax-free bonds have a long maturity period, ranging from 10 to 20 years, making them suitable for long-term investment goals.

4.    High Credit Rating: These are issued by government-backed entities and have a high credit rating, indicating a low risk of default.

5.    Non-Convertible: They are non-convertible and cannot be converted into equity shares of the issuing company.

6.    Tradable: Tax-free bonds can be traded in the secondary market, providing investors with liquidity and an exit option.

7.    Lock-In Period: Tax-free bonds come with a lock-in period during which they cannot be redeemed before maturity. They can be traded in the secondary market.
 

Benefits of tax-free government bonds

Tax-free government bonds offer several benefits to investors. 

1.    Tax Benefits: The interest earned on tax-free government bonds is exempt from income tax, making them an attractive option for investors looking to generate tax-free income.

2.    Guaranteed Returns: Tax-free government bonds provide a guaranteed fixed rate of return. This ensures investors receive a stable and predictable income stream.

3.    Low Risk: Tax-free government bonds are issued by government-backed entities with a high credit rating, indicating a low risk of default. This makes them a relatively safe investment option compared to other fixed-income instruments.

4.    Long Maturity Period: Tax-free government bonds have a long maturity period, ranging from 10 to 20 years. This makes them suitable for long-term investment goals, like retirement planning or education funding.

5.    Liquidity: Tax-free government bonds are tradable in the secondary market, providing investors with liquidity and an exit option.

6.    Diversification: Investing in tax-free government bonds can help investors diversify their portfolios, reducing the overall risk of their investments.

Tax-free Bonds for Senior Citizens

Senior citizens need more security in their finances than anything else. Tax-free bonds are a good option owing to the following advantages:

●    They are backed by government organisations, making it a safer investment avenue.
●    They are a stable source of income via interest payments.
●    Tax-free bonds provide capital security.

Tax-free Bonds 2023

 Below is a list of tax-free bonds in India.

These government websites keep updating the details about the upcoming tax-free bonds.

Conclusion

Tax-free bonds can be a valuable investment option for individuals seeking a tax-efficient way to generate steady income. These bonds provide tax exemption on the interest earned, making them lucrative for investors in higher tax brackets. However, it's essential to carefully consider the creditworthiness of the issuer and the overall market conditions before investing in tax-free bonds. 

As with any investment, diversification and a long-term investment horizon are key to managing risk and maximising returns. Ultimately, tax-free bonds can be an excellent addition to a well-rounded investment portfolio for those looking to balance risk and return while minimising tax liability.