Bonds are investment instruments issued by corporates and governments to raise funds. Prospective investors receive returns according to a predetermined interest rate for investing their funds. Tax-free bonds do not attract taxes and are lucrative investments for individuals, trusts, HUFs, etc. Read on to get a detailed insight on tax-free bonds and how to invest in them.
These bonds are issued by different public sector undertakings (NHAI, PFC, NABARD, HUDCO, REC, etc.) to raise funds for a specific purpose, for a fixed tenure, and are offered at a predetermined coupon rate. As PSUs issue these, there is a very low credit risk.
Section 10 of the Income Tax Act allows exemption from interest earned on these bonds. These bonds are also traded on stock exchanges. Note that the market price of bonds is crucial as if the interest rate falls, bond prices will rise, and they may trade at a premium with regard to their face value.
These bonds offer returns to investors at a predetermined coupon rate. All interest earned from these is completely tax-exempt irrespective of the income slab of the investors. The coupon rate that the issuer can offer is dependent on the yield of government securities at that time. The rate does not change during the entire duration of the holding period.
Interest offered is fixed based on two factors: One is the rating of the enterprise issuing the bond, and the other is the status of the investor (whether he/she is a retail investor or a high net worth individual).
|Interest earned is credited every 6 months. The interest rates are also high as compared to other investment instruments.
|In the case of tax-saving bonds, interest earned is paid annually to investors. As a result, the rate is slightly lower than tax-free bonds.
|Only the interest is eligible for tax exemption. The investment amount is not deductible under Section 80C.
|Initial investment of up to Rs. 20,000 is exempt under Section 80CCF.
|Suitable for Investment
|Tax-free bonds are suitable for individuals and entities that fall under a high tax bracket.
|These are suitable for long-term risk-averse investors who aim to save taxes.
Given below is a list of some of the best-performing tax-free bonds in India:
Investment in tax-free bonds can be done either offline or online mode by prospective investors. The subscription period is open for a limited time only, and one has to apply within that window to invest in the financial instruments. Individuals or entities going for an offline mode of investment need to complete their KYC with the issuing authority.
Individuals can also acquire these bonds post-issuance through their trading accounts. Investment in them after the issuance is just like share trading.
Furthermore, tax-free bonds for senior citizens may be an efficient investment strategy as they look for stable returns with low risk. However, individuals looking for liquidity in their investment plans can avoid this as it is highly illiquid in nature owing to the lock-in period.
Tax-free bonds have a pre-set maturity period. You can only withdraw the amount after the maturity period is over. However, if you require funds urgently, you can trade them on the bond markets. You need to keep in mind that the entity that issued the bonds will not be able to buy back their bonds.
As per Section 112 of the Income Tax Act, profits earned from the sale of tax-free bonds in the previous year are taxable as per the applicable income tax slab of the seller. This is applicable only if these bonds are sold within a year after purchase.
If you have traded tax-free bonds after 12 months, LTCG (Long Term Capital Gains) will be applicable at a 10% rate without the benefit of indexation.
Tax-free bonds are a very popular form of investment. They are useful for keeping one’s tax liability in check. However, one must compare returns, investment duration, and ratings of issuers before taking a plunge.
Ans: Bonds carry low-risk while stocks are high-risk investment options. When it comes to mutual funds, the risk depends on the type of investment. In many ways, experts consider bonds to be a safer option with secure returns. However, the investment needs are different for different people. So, there isn’t any particular asset class that is perfect for every investor.
Ans: RBI issues these bonds on behalf of the Government of India. They come with a tenure of 7 years and offer interest at the rate of 7.75% per annum. However, they do not offer tax benefits to investors.
Ans: Tax-free bonds are a relatively safe investment option. The government backs these debt instruments. Hence, the chances of default are quite rare. They are suitable for risk-averse investors who are looking to add stability to their portfolio.
Ans: The following are some disadvantages of tax-free bonds:
These bonds have low liquidity as they come with a lock-in period.
Such bonds are prone to interest rate risk
These bonds tend to get oversubscribed quickly, and investors fail to get allotment
Ans: Local governments issue municipal bonds to raise funds for various social welfare purposes. Municipal bodies use such financial instruments to raise funds that are required for building hospitals, schools, and drinking water facilities in their area.
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
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