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Invest in Tax-Free Bonds: Understanding the Benefits and Who can Invest?

When looking for profitable investment opportunities, tax-free bonds prove to be one of the most sought-after solutions. Not only do these bonds offer more reliability, but they also ensure higher returns.

  • 3,336 Views | Updated on: Mar 21, 2024

The government issues tax-exempt bonds to the public for a variety of budgetary needs. The investor, with a fixed deposit, can commit a large quantity of money to tax-free bonds in exchange for a steady return on their investment.

Fixed-income tax-free securities are universally favored, while safe capital investments are preferred. However, they give lesser returns than equities and other high-risk investing choices. In addition, the return decreases further owing to tax liabilities. Nevertheless, there is one fixed-income product with a negligible tax burden, and that is the tax-free bond.

This article focuses on the definition of tax-free government bonds, their primary benefits, and their operation.

What are Tax-Free Bonds?

As the name implies, tax-free bonds are exempted from taxation since they enable the government to earn interest revenue, making it a popular option. Government agencies generally issue these bonds, reducing the danger of interest non-payment to a minimum.

A government entity issues tax-free bonds to raise revenue for a specific purpose. Bonds issued by municipal entities exemplify these bonds. They give a set interest rate and seldom default, making them a low-risk investment opportunity.
As per Section 10 of the Income Tax Act of India, 1961 the 100% tax exemption on interest is its most appealing feature. Generally, tax-free securities have a maturity of ten years or more. The government spends the proceeds from these bonds on housing and infrastructure initiatives.

Who Needs to Invest in Tax-Free Bonds?

Tax-exempt bonds are ideal for investors seeking a stable income, such as retirees. As government entities typically issue these bonds for a longer duration, the failure risk is relatively low. You are guaranteed a fixed income for a longer term, often ten years or longer.

The money obtained via the issue of these bonds is invested in infrastructure and housing projects by government businesses. Therefore, tax-exempt bonds are the best option for investors with the highest tax rate. High-net-worth (HNW) individuals, Hindu Undivided Family (HUF) members, trusts, cooperative banks, and qualified institutional investors can benefit from tax-free bonds.

Benefits of Tax-Free Bonds

Tax-free bonds offer a number of advantageous features. The following are the principal advantages of tax-free bonds.


In the case of tax-exempt bonds, all interest income is exempt from taxation. Additionally, tax deducted at source (TDS) does not apply to these bonds. Therefore, the original amount invested in tax-free bonds does not qualify for a Section 80C tax deduction. Which makes it necessary to record your interest income. You can acquire tax-free bonds both physically and electronically. Compared to bank FDs, tax-free bonds give investors in the highest income tax bracket a tax-efficient return.

Risk Factors

As the government gives these programs, there is a relatively minimal likelihood of failure on principle and interest payments. Additionally, it also provides capital protection and a monthly or yearly guaranteed income, making it highly secure.


Tax-free bonds cannot be liquidated as rapidly. Since government bonds are long-term investments with longer lock-in periods, it may be difficult to liquidate tax-free bonds, which in turn can be beneficial to meet long-term financial goals.

Transaction and Insurance

Tax-exempt bonds can be issued via Demat or in physical form. In addition, you may purchase tax-free bonds on the secondary market for short-term financial objectives.

Interest Rate

The range of interest on tax-free bonds is typically between 5.50% and 6.50%, which is quite favorable when the tax exemption on interest is considered. A bondholder receives yearly interest. However, the rates are subject to change because they are based on the current yield on government securities. For example, investing in tax-free bonds at current rates might give a return of 6% tax-free.

Did You Know?

Bonds that are exempt from taxation may be traded on stock exchanges. On the stock markets, these tax-free bonds are available for purchase and sale by any potential investor.


Bonds exempt from federal income tax are a viable alternative for those seeking a steady stream of tax-free earnings. Bonds issued by the government don’t incur capital gains tax and are an alternative to fixed deposits and corporate bonds. This fail-proof backup plan won’t leave you high and dry if other plans fail.

    Key Takeaways

    The primary benefits of tax-free government bonds are mentioned below.

  • Tax exemption
  • Negligible risk
  • Liquidity
  • Transaction and issuance
  • Interest rate

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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