Tax Free Bonds
As an investor, would you choose taxable investments or those that generate tax-free returns for you? The answer is simple. Nothing attracts an investor more than a tax-free investment. Similarly, bonds can be both taxable and tax-free. The difference is that you do not need to pay taxes on income from tax free bonds.
What are Tax Free Bonds?
Tax-free bonds are government bonds that aim to provide a regular tax-free coupon income. Also known as tax-free government bonds, these bonds can only be issued by government bodies, such as municipal corporations, NHAI, etc., to raise funds for development projects. These bonds are issued for the long term only. Hence, they can also be called tax-free municipal bonds.
However, you must ensure that you do not need to withdraw the invested money soon. This is because the lock-in period for such bonds is more than 10 years since the government raises the money for big projects. You can alternatively trade these bonds on the bond markets if they are listed.
The interest payout on tax-free bonds is lesser than on regular bonds due to tax relaxation. The coupon rate at which interest is paid can also be called tax-free bond yield. The following table depicts the difference between the returns of a tax-free and a regular bond.
Popular Tax-Free Bonds in 2022
Here is the list of the most popular tax-free bonds of 2022:
Power Finance Corporation tax-free bond
Housing and Urban Development Corporation tax-free bond
Features & Benefits of Tax-Free Bonds
✓ Fixed Interest Rate: The interest on non-taxable bonds is fixed and is payable at regular intervals. You will receive this amount until the maturity of the bond. The interest amount is usually risk-free due to the involvement of government corporations. The interest payout on these bonds is usually made half-yearly or yearly.
✓ Tax-Free Returns: You do not have to pay any taxes on the interest received by you on these bonds. Hence, the interest rates can be called the tax-free bond’s rate. Although, the capital gain on sale or redemption of these bonds is taxable under the Income Tax Act, 1961.
✓ Highly Secure: The investment in these bonds is highly secure. There are hardly any chances for default on a government bond. This quality makes them the most attractive bonds for investment.
How Can You Invest in Tax-Free Bonds?
You can invest in a tax-free bond in 2 ways:
Bond Issue: You can apply for these bonds while the subscription is open. Both online and offline applications can be filed by filling a form and submitting your KYC details, including your PAN Card.
Through Trading: Post-issuance, tax-free bonds can be purchased online using a trading account through a broker.
Why Should You Invest in Tax-Free Bonds?
Tax-free bonds are a much better option than volatile markets and risky investments if you are highly risk-averse. It can help you earn a regular income for an extended period and benefit capital gains.
Online Fintech platforms like Aspero build a nexus between the investors and the borrowers to carry out transactions smoothly within a highly secure environment. With 100% transparency and simplicity, you can easily invest in your favourite tax-free bonds and track your investments in real time.
How are Tax-Free Bonds Taxed? – Tax Implications on Tax-Free Bonds
The interest accumulated from tax-free bonds is considered tax-free if you can hold the bond until maturity. Hence, there is no TDS.
If the bonds are sold in the secondary markets, the transactions are entitled to tax deductions.
If you sell your particular bond in the secondary market after 12 months, your profit will be taxed at 10%.
How to Redeem Your Tax-Free Bonds
Tax-free bonds are very easy to redeem. The holder of these bonds has to hold these bonds till maturity. Once the bonds are matured, they can be sold to the issuer bank/corporate and pave the way for a fixed income tax-free.
Further, such tax-saving bonds can be traded in the secondary market, and the holder can earn profit. But these profits are liable to be taxed by the govt.
Short-term gains: When the holder sells these bonds in the market before the 12 months of its purchase will attract tax as per the holder’s income slab under section 112.
Things to Remember before Opting for Tax-free Bonds
Free Bonds are the safest means of investment with a long lock-in period. Hence, investors must be aware of their financials before diving into these bonds.
Fund managers suggest these bonds to minimise tax liability and to diversify the riskiness of the portfolio. That is the reason free bonds are most suitable for high-income group people.
Thus, it is imperative to know a few things before investing:
Who should Invest in Tax-Free Bonds?
Tax-free bonds offer longer tenure, fixed income for an extended tenure, and a low risk of default. Hence, they make the ideal choice of investment for senior citizens.
Such investors who fall in the category of the high-tax bracket should invest in tax-free bonds. The entities that fall under the category of the high-tax bracket include HUF members, high net-worth individuals (HNI), cooperative banks, trusts, and certified institutional investors who are qualified to invest in such bonds.