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.
Tax-Exemption
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.
Liquidity
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.
Conclusion
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.
