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What are Tax Free Bonds and How to Invest in it ?

Consumers are constantly looking for investments with high potential returns. Tax-free bonds are among the most sought-after assets on the market due to features like no tax on returns.

What's the process for Tax-Free Bonds?

Tax-free bonds are issued by a government organisation to raise money for a specific objective. One kind of these bonds is municipal bonds, which are issued by municipal corporations. They are a low-risk option for investments because they have a set interest rate and rarely default.

As implied by the name, its most alluring feature is the complete tax exemption on interest granted by Section 10 of the Income Tax Act of India, 1961. The typical long-term maturity of tax-free bonds is ten years or more. The government uses the proceeds from these bonds to pay for housing and infrastructure initiatives.

Who should buy bonds exempt from taxes?

Bonds that are tax-free are a great option for investors seeking a stable income, such as senior folks. The default risk is quite low because government corporations frequently issue these bonds for a longer term and you are assured a fixed income for a longer period of time—often 10 years or more.

The funds raised from the issuance of these bonds are used by governments to fund housing and infrastructure initiatives. For investors in the highest tax bracket, tax-free bonds are the best option.

Tax-free bonds are frequently preferred by high net worth (HNI) individuals, HUF members, trusts, co-operative banks, and qualified institutional investors.

What characteristics set apart tax-free bonds?

The interest from tax-free bonds is not subject to any taxes. These bonds do not have any tax deducted at source (TDS) at all. Because the capital invested in tax-free bonds does not qualify for a tax deduction under Section 80C, it is essential to keep track of your interest income.

Tax-free bonds can be purchased both physically and electronically (Demat). Tax-free bonds offer investors in the highest income tax brackets a yield that is tax-efficient when compared to bank FDs.

Hazard elements

Due to the fact that these programmes are offered on behalf of the government, there are relatively minimal chances of missed principal and interest payments. It also provides a fixed monthly or annual income as well as financial security. It is therefore regarded as being relatively safe.


For instance, debt mutual funds can be redeemed more quickly than tax-free bonds. The tax-free bonds might not be as simple to sell as other assets because of the longer lock-in periods and long-term nature of government bonds.

A fixed period

The lock-in period for tax-free bonds is longer and can last anywhere between 10 and 20 years. Money cannot be withdrawn before the maturity date. Please be sure you won't need this money any time soon after investing if you do.

Liberation and exchange

Tax-free bonds may be issued physically or electronically through a Demat account. To meet short-term financial objectives, you can purchase tax-free bonds on the secondary market.


These bonds' purchase price has a big impact on the returns you get from them. This has happened as a result of the small amount of trade and the few interested buyers or sellers.


After deducting the tax exemption on the interest on these bonds, the interest rate on tax-free bonds typically varies from 5.50% to 6.50%.

Every year, interest is paid to bondholders. Yet, the rates are erratic since they depend on the market value of current government holdings. If you purchase tax-free bonds at the present yields, you may earn 6% without paying any taxes.

What kind of bonds are often tax-exempt?

Numerous public sector organisations have issued bonds that are tax-free. Among the most well-known are Indian Railways, Rural Electrification Corporation, National Highway Authority of India, and NTPC Ltd.

Other examples include Power Financing Company, Housing and Urban Development Corporation, Indian Renewable Energy Development Agency, and Rural Electrification Limited.

How to Invest in Tax Fee Bonds ?

Using a Demat account, bonds can be traded in both physical and digital form. How to Invest in Bonds Tax-Free Trading opportunities exist for tax-free bonds. As a result, investing in these bonds is easy and very profitable. Remember that the subscription term for the investment is only valid for a finite period of time.

You must provide your PAN information by selecting the physical format and completing your KYC. Investors can apply to subscribe for government bonds either online or offline.

On the other hand, an investment is made through a trading account if a buyer wants a bond after it has been issued. It is comparable to trading shares on a stock exchange because of this.

Redeeming Tax-Free Bonds: Steps to Take

If the period has passed, redeeming tax-free bonds is a straightforward procedure. Bonds cannot be redeemed before 10 to 20 years; they can only be traded between investors on stock exchanges.

Additionally, the original bond issuer is prohibited from repurchasing the bond. Section 112 also taxes the profit you make after the transaction. As a result, if you sell the bond before the end of the year, your capital gains tax liability will be determined using your income tax rate.

If you sell it after a year, there will be no indexation advantage and a 10% long-term capital gains tax. Finally, tax-free bonds provide income that is free from risk.

Before they mature, these bonds can be traded on secondary markets. However the government hasn't made a statement about the issuance of these bonds since 2016. Investors should be aware of the duration and interest rate if they are thinking about investing in PSU firms.

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