Would you rather invest in taxable investments or those that offer tax-free returns? Answer: It’s simple, tax-free investments are the most attractive to investors.
Bonds can also be taxed and tax-free. If you are looking for a secure investment to increase your returns, you should consider investing in tax-free bonds.
What are tax-free bonds?
Tax-free bonds refer to government bonds that aim to generate regular income tax-free. Also known as Tax-Free Government Bonds, these bonds are only issued by government entities, such as municipalities, corporations, NHAI, etc., to raise money for development projects. They can only be issued on a long-term basis. They can be referred to as municipal bonds that are tax-free.
You must not withdraw your money too soon. The lock-in period for these bonds is over 10 years since the government has raised the money to fund large projects. You can trade these bonds on the bond market if they are listed.
Due to the tax relaxation, interest payments on tax-free bonds are lower than regular bonds. Tax-free Bond Yield is another name for the coupon rate.
It is important to note that the tax-free status of these bonds only applies to their interest. Capital gains from the sale of bonds or redemption after the term are taxed. Tax free bonds in India are popular.
Benefits & Features of Tax-Free Bonds
Fixed interest rate: The interest on non-taxable bonds is fixed and payable regularly. This amount will be paid to you until the bond’s maturity date. Due to the involvement of government corporations, interest amounts are usually risk-free. Interest is paid on these bonds, usually every half-year or annually.
Tax-Free Returns: You do not need to pay taxes on interest you receive on these bonds. The interest rates are called tax-free bond’ rates. The capital gain from the sale or redemption is taxed under the Income Tax Act of 1961.
High Security: Investing in these bonds will be highly secure. A government bond has very little chance of defaulting, making it the best investment bond.
Less liquid: Tax-free infrastructure bonds have a minimum lock-in period and are not refundable before their tenure is complete. Therefore, they are less liquid than other investments.
Long-term: Departments such as NHAI, REC, etc., issue bonds for infrastructure. Because the projects are long-term, the tenure of these bonds is typically more than 10 years.
What are the Tax-Free Bonds, and how can you invest in them?
There are two ways to invest in a taxable bond:
Bonds Issued: You can apply for these bonds while the subscription period is open. You can file online or offline applications by completing a form and submitting your KYC information, including your PAN Card.
Trading: Tax-free bonds issued after issuance can be purchased using an online trading account with a broker.
You can trade these bonds on the stock exchange through your Demat account.
The government issues tax-free bonds from time to time for different projects. You must, therefore, keep an eye out for the next tax-free bond issue. It is advantageous to buy these bonds at their issue price, as they become less attractive to invest in when the prices increase.
Why should you invest in tax-free bonds?
Tax-free bonds can be a better investment than volatile markets or risky investments if you’re averse to risk. You can earn a steady income over a long period and enjoy capital gains.
How are tax-free bonds taxed? Tax implications on tax-free bonds
- If you hold the tax-free bond to maturity, then the interest earned is tax-free. There is, therefore, no TDS.
- Tax deductions are available for transactions where bonds are sold on the secondary markets.
- Your profit is taxed 10% if you sell your bond on the secondary market within 12 months.
- If the bond is sold within 12 months, the capital gain will be taxed based on the income tax slab.
- Tax free bonds are recommended for those who fall under the high tax category.
For example, Arun and Jay earn Rs. Arun invests 2 lakhs in a fixed deposit account with an interest rate of 6% per year, and Jay spends Rs. Tax-free bonds with a 5.5% annual interest rate for 10 years are worth Rs. In this scenario, Arun and Jay would both fall within the 30% tax bracket.
Who Should You Invest in Tax Free Bonds?
Tax-free bonds have a longer term, a fixed income over a long period, and low default risk. They are, therefore the best investment option for seniors.
Investors who fall into the category of high-tax brackets should invest in bonds that are tax-free. High-tax bracket entities include HUFs, high-net-worth individuals, cooperative banks, trusts and institutional investors certified to invest.