Tax Free Bonds are beneficial for longer duration

| December 29, 2013

Tax Free Bonds are beneficial for longer duration

Things you should know about Tax free bonds:- 

    • What are tax-free bonds: These bonds are mostly issued by government enterprises and pay a fixed coupon rate (interest rate). As the proceeds from the bonds are invested in infrastructure projects, they have a long-term maturity of typically 10, 15 or 20 years.
    • Tax benefits: The income by way of interest on tax-free bonds is fully exempted from income tax. The interest earned from these bonds does not form part of your total income. There is no deduction of tax at source (TDS) from the interest, which accrues to the bondholders. But remember that no tax deduction will be available for the invested amount.
    • Interest rate: The coupon (interest) rates of tax-free bonds are linked to the prevailing rates of government securities. So these bonds become attractive when the interest rates in the financial system are high.
    • Interest payment: The interest on these bonds is paid annually and credited directly in the bank account of the investor.
    • Tax free bonds vs bank fixed deposits (FDs): The interest earned on bank FDs and other normal bonds are added to the income of the investor and taxed as per the income-tax slabs. As interest earned from tax-free bonds are not taxed, investors in higher tax brackets mostly earn a better post-tax return than from FDs. But remember, the bank FDs score over tax-free bonds in terms of liquidity as these bonds have a longer maturity tenure.
    • Credit risk: Since tax-free bonds are mostly issued by government-backed companies, the credit risk or risk of non-repayment is very low.

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