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What are Tax Free Bonds

4 Mins 15 Dec 2022 0 COMMENT

By the end of this article, we shall discuss in detail:

  • What tax-free bonds are?
  • What are the primary benefits of investing in tax-free bonds?
  • What are the essentials to keep in mind before opting for tax-free bonds?
  • How to invest in tax-free bonds?
  • Who can invest in tax-free bonds?
  • Distinguish between tax-free bonds and tax-saving bonds.
  • Wrapping up

Let's begin with understanding the sole topic, what are tax-free bonds?

These bonds are typically issued by different public sector undertaking, some of which include National Highways Authority of India (NHAI), Power Finance Corporation Ltd. (P.F.C.), National Bank for Agriculture and Rural Development (NABARD), Housing and Urban Development Corporation Ltd. (HUDCO), etc, with the primary motive to raise funds for a specific reason for a fixed time period, and are offered at a pre-determined coupon rate. As issued by the PSUs, these include a very low credit risk. Section 10, Income Tax act allows the exemption of interest earned on these bonds. Also, the bonds are traded on stock exchanges.

Investors generally seek to minimize their overall tax liability by investing in bonds that provide exempted interest income. These bonds typically have lower yields than taxable bonds but the after tax return on tax-free bonds can be higher than the after tax return on taxable bonds.

Issuers of tax-free bonds usually structure the bond issue so that the interest payments are made at periodic intervals (semi-annual or annual) and the principal is repaid at maturity.

What are the primary benefits of investing in tax free bonds?

Following are the benefits of investing in tax-free bonds-

  • For starters, it can be a great investment for those looking to save on taxes.
  • One of the key benefits of investing in a tax-free bond is that, these are considered to be highly secured. As issued by the Central Government, the probability of default of the interest payment as well as principal repayment is quite low.
  • The bonds being completely tax-free provide their investors tax-free benefits. The interest received is calculated as a part of the total annual income.
  • The bond provides interest annually which gets credited directly in the bank account of the investor.
  • One of the greatest benefits is that these bonds provide steady returns for longer terms like ten or twenty years.
  • Ta-free bonds are considered to be a stable investment. Investors in tax free bonds can feel confident that their investment will be repaid even if the issuer experiences financial difficulties.
  • Additionally, investors may also benefit from higher interest rates. Tax-free bonds have lower interest rates than taxable, making them a more conservative option for those looking to grow their money.

What are the essentials to keep in mind before opting for tax free bonds?

Tax-free bonds may function as an outstanding investment instrument as it is exempted from tax. Before you invest, it's essential to understand the fundamental factors.

  • In terms of investing, there are multiple options to choose from. One option is tax free bonds, allows the investor to avoid paying taxes on the interest that they earn.
  • When it comes to saving for retirement, people look for ways to minimize their tax burden. The option that has become increasingly popular in recent years is investing in tax-free bonds. As the name suggests, these bonds are exempt from income tax, which means they can be a ideal way to boost your retirement savings.
  • The bonds can be traded on the stock exchange. Investors can be buying and selling these bonds during trading.
  • Tax exempt bonds are issued in both electronic and physical forms.
  • The bonds have low credit risk as it is issued by the government.
  • The rate of interest is between 7.3 and 7.5 percent per year.

How to invest in tax free bonds?

These are one of the best investment options available in India. They offer several benefits like safety, security and high returns. Investing is very simple and straightforward process. You can invest in them either in the physical format or in the Demat form.

You will need to have a PAN card and an account with a designated bank or financial institution. The process of investing is very simple and can be done online.

Once you have purchased the bonds, they will be credited to your account on the specified date. You can hold them for as long as you want and redeem them at any time.

Who can invest in tax-free bonds?

The following categories of investors can invest in these bonds:

  • Listed buyers recognized by SEBI (Disclosure and Investor Protection) 2000.
  • LLPs, partnership firms, cooperatives, rural banks, and other authorized entities.

Tax Free Bonds – Meaning And How to Invest in Them | ICICI Direct

Distinguish between tax-free bonds and tax-saving bonds.

The major point of difference between these are listed below -

  • In a tax-free bond, the interest income achieved from investing in these bonds is free from taxation as per Section 10 of the Indian Income Tax Act, 1961.

On the other hand, tax-saving bonds do not offer this benefit. In such a bond, only the initial investment is free from tax.

  • Tax-free bonds offer a slightly higher rate of interest.

In contrast, tax-savings bonds offer lower interest rates.

  • In a tax-free bond, any retailer can invest in the bond worth up to Rs. five lakhs.

On the contrary, in the case of tax-savings bonds, the investing criteria are limited.

  • In terms of investing, the tax-free bonds are absolutely free and neither do they include any caps.

But, tax-savings bonds are investment instruments, especially for individual investors who benefit from tax exemption on investing an amount maximum of Rs. 20000 under Section 80C, Indian Income Tax Act.

Wrapping up

In conclusion, the tax-free bonds are an ideal way to save money on your taxes. They are easy to find and there are many different types to choose from. With all the existing benefits, it is no wonder that tax-free bonds are becoming more popular.

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