In the case of tax-free bonds, the interest income is entirely tax-exempt. Also, the tax deducted at source (TDS) does not apply to these bonds. However, it is advisable to declare your interest income as the principal amount invested in tax-free bonds do not qualify for a tax deduction under Section 80C.
You may purchase tax-free bonds in both, physical and the Demat form. Tax-free bonds, when compared to bank FDs, offer a tax-efficient return to investors who fall in the highest income tax brackets.
Chances of default on principal and interest payment are very low as these schemes are issued on behalf of the government itself. Also, it offers capital protection and a fixed monthly or annual income. Hence, it can be considered quite safe.
You cannot liquidate tax-free bonds as quickly as, say, debt mutual funds. Since government bonds are long-term investments and have more extended lock-in periods, liquidation of the tax-free bonds may not be that easy.
Tax-free bonds have a longer lock-in period that ranges from 10 years to 20 years. You cannot withdraw your money before the maturity date. Therefore, please make sure that you do not need this money shortly after investing.
Issuance & transaction
Tax-free bonds are issued through a Demat account or in physical mode. You may buy tax-free bonds from the secondary market to achieve short-term financial goals.
The returns you make on these bonds are primarily dependent on the purchase price. This is because they are traded in low volumes with a limited number of interested buyers or sellers.
The rate of interest offered on tax-free bonds generally ranges between 5.50% to 6.50%, which is fairly attractive when considering the tax exemption on interest for these bonds.
A bondholder receives the interest annually. However, the rates are subject to fluctuations as they are related to the current rate of government securities. You could get a 6% tax-free return if you invest in tax-free bonds at current yields.
Government bonds allow federal, state and local governments to accomplish critical projects. Municipal bonds are issued by city and county governments for public works projects like schools, highways and hospitals. The federal government issues treasury bonds that mature between 10 and 30 years. Consumers also can purchase treasury inflation protected securities (TIPS) that are bonds that protect against inflation. Historically, government bonds have been low-risk investments, but they carry interest rate risk and don’t have the same earnings potential as higher-risk investments.