Ever wondered about safe ways of investing money? Does the stock market scare you?
Are you confused about the best way to invest without worrying about liquidity?
Do you want a tax-free income from your investments? Do you want low-risk investments?
Investing in Tax-free bonds might be the way to go! Let’s learn more about them.
How do tax-free bonds work?
In simple words, tax-free bonds are government-issued bonds. Under Section 10 of the Income Tax Act, they are issued to collect funds for different causes. These bonds offer a fixed interest rate. They are similar to fixed deposits; you are offered a fixed, tax-free interest rate for a lump sum of money. Since the interest rate is set, it is a low-risk investment with guaranteed returns.
Often, the breakdown of liquidity makes certain investments risky. You don’t have to worry about liquidity while investing in tax-free bonds.
The best part of tax-free bonds is that there is no risk involved. In addition, it allows you to earn a regular annual income without interest rates. Tax-free bonds usually have a long-term maturity. Investing in these bonds can earn tax-free returns for up to 20 years. Also, tax-free bonds’ interest rate is much higher than other investments.
You can also sell these bonds upon maturity. The National Stock Exchange enlists the price for these bonds.
Types of Bonds: Where to invest?
Government-issued tax-free bonds are one of the safest investment options. However, there are two types of such bonds – tax-free and tax-saving.
- Tax-Free Government Bonds: Such bonds have zero tax on interest income. You can invest up to INR 5 lakh. Tax-free bonds offer higher interest than tax-saving bonds. They come with maturity periods ranging from 10 to 20 years. Also, only Indian nationals and Unified Hindu families are allowed to invest in these bonds.
- Tax-Saving Bonds: These bonds provide an initial tax exemption under Section 80CCF of the Income Tax Act. You can avail of tax exemption against an investment of Rs 20,000 per financial year. These bonds have a buyback clause that allows investors to redeem investments after 5 or 7 years. So, tax-saving bonds are a good option if you want short-term investments.
Tax-Free Bonds: Features and Benefits
Tax-free bonds are favoured because of the following features:
- Liquidity: Tax-free bonds might be a good choice if you hesitate to invest because of liquidity. These bonds can be traded or sold according to the ongoing market price. However, you must pay taxes for any profit you earn by selling these bonds.Another selling point is that tax-free bonds are form-flexible. They can be held in physical or dematerialized bonds. Therefore, you can buy them directly or use your Demat account.
- Interest: The central government decides these bonds’ interest rates. You will receive the interest amount annually. Whatever amount is earned from interest is tax-free.
- Tenure: Tax-free bonds serve as long-term investments. Based on your interest, you can invest in these for up to 15 or 20 years.
Tax exemption is not the only benefit of these bonds. Tax-free government bonds assure many other benefits, like:
- The government of India supports these bonds. Therefore they’re a very safe investment. You don’t have to worry about your money even if the company goes bankrupt. In such cases, company assets are liquidated, and investments are returned to bondholders.
- Apart from the principal amount returned on maturity, you can earn guaranteed interest from these bonds every year.
- There is no upper limit to investment in Tax-free government bonds. The higher the tax bracket, the more profit you can earn. Therefore, they are a great investment option if you fall in the 30% or above tax bracket.
- The price of these bonds is listed in the stock market. So, you can easily sell your bonds when their value appreciates.
- Furthermore, fixed deposits offer interest rates ranging from 4.5 to 5% in the short term. Tax-free bonds offer interest rates of up to 6%.
How to invest in tax-free bonds?
If you are interested in investing in tax-free bonds, you can buy these bonds when the government initiates a subscription. These bonds are available for very short durations. You can apply to the issuing company when the subscription for investment starts.
You must submit KYC and PAN details online and offline to receive these bonds. Currently, there are no tax-free government bonds available in the primary market. But previously issued bonds can be bought on the stock exchange.
You can buy or trade these bonds like equities in the secondary market through your Demat accounts. NABARD, HUDCO, NHAI, PFC, REC and IFC are popular bonds among investors.
How to redeem tax-free bonds?
You can redeem your investment upon maturity once the bond’s tenure is completed.
Since tax-free bonds are considered long-term investments with tenures of 10-20 years, they cannot be redeemed before maturity. However, if you do not wish to hold these bonds any longer, you can trade them in the stock market. Moreover, the proceedings are credited to your bank account if you sell these bonds in exchange.
If you sell your bonds within a year of purchase, you are liable to pay taxes. However, if you retain the bonds for more than a year, tax payment on returns is 10% without indexation.
If you qualify for the higher tax brackets or wish to make long-term investments, tax-free government bonds are ideal. These bonds offer a good maturity period and greater interest rates than fixed deposits. They are also very safe investments since the government backs them. You can hold these bonds long-term or trade them like equity in the secondary market. Since the government determines these bonds’ prices, you don’t have to worry about market fluctuations. Furthermore, you can earn guaranteed interest returns annually.
Also Read: Top Short-Term Stocks To Buy In 2023