What are tax-free bonds?
Government-backed entities such as, NHAI, REC, PFC, etc. issue tax-free bonds to raise capital. The capital is meant for long-term projects and these bonds have tenors of 10, 15 or 20 years. The interest earned from these bonds is exempt from taxation. Capital gains from the sale of bonds are taxable.
STCG – Short- Term Capital Gains (< 12 months); LTCG – Long- Term Capital Gains (>12 months)
Features of Tax Free Bonds
Since they are issued by government backed entities, there is a very low probability of default. Consequently, these bonds have high credit ratings. The returns are linked to government securities with similar maturities. Since the interest earned is tax free, the post-tax returns when compared to similar bonds turns out to be more efficient. The bonds are traded on the exchange, this gives investors the option to exit before maturity. The interest payment occurs on an annual basis. There is no investment limit, but retail investors may earn more interest.
Tax free bonds are meant for investors who want to lower their tax liability and are ideally suited for those in the highest tax bracket. Investments in tax free bonds alone may not be sufficient to meet long-term financial goals. Although they are exchange traded, the volume is sparse. This means that entering or exiting these investments may prove difficult. Additionally, identifying a fair price becomes harder. These bonds are meant for investors who are seeking stable cash flows and safety.