Top 10 Tax-Free Bonds

6 min read • Published 24 January 2024
Written by Anshul Gupta

Bonds are one of the most sought-after modes of investment in the fixed-income market, given their payout schemes, attractive coupon rates, and a great tool to diversify investor portfolios. However, with the gains that come along with bonds, the downside to it is the tax implications. In general, the interest gained from bonds is taxable by law. With tax-free bonds, it’s a different story, however. 

In this blog, we’ll walk you through what tax-free bonds are, their benefits, the average yield you can expect, and much more. With that being said, let’s get into it! 

What are Tax-Free Bonds?

Tax-free bonds, offered by public sector entities, present a secure investment for individuals seeking steady income. These bonds stand out for their ability to generate annual interest earnings exempt from income tax. This feature makes them a great choice for income-seeking investors and enhances the potential for tax savings. 

Investors receive the principal amount back when the bonds mature, aligning with the standard practice of bond investments. This makes them suitable for those prioritising safety and tax efficiency in their investment portfolio.

List of Top 10 Tax-Free Bonds

Here is the list of the top ten tax-free bonds that are popular based on the coupon rate being offered:

NameIssue SizeMaturityCoupon
National Housing Bank665.72 Cr13 Jan 20349.01%
Power Finance Corporation Ltd.861.96 Cr16 Nov 20338.92%
NTPC Limited399.97 Cr16 Dec 20338.91%
National Housing Bank85.73 Cr13 Jan 20298.88%
Power Finance Corporation Ltd.353.32 Cr16 Nov 20288.79%
National Housing Bank713.43 Cr13 Jan 20348.76%
National Highways Authority Of India1189.81 Cr05 Feb 20298.75%
NTPC Limited91.39 Cr16 Dec 20288.73%
Rural Electrification Corporation Limited1171.48 Cr24 Sep 20288.71%
National Housing Bank421.99 Cr24 Mar 20298.68%

Types of Tax-Free Bonds

Tax-free bonds are investments issued by public organisations aimed at funding key areas of the economy:

  • Infrastructure Bonds: Offered by companies dedicated to building fundamental facilities and services like roads, airports, and energy plants.
  • Housing Bonds: These are launched by groups such as the National Housing Bank to support the development of reasonably priced homes for the public.
  • Power Bonds: Provided by corporations involved in electricity generation, these bonds are crucial for the growth and repair of power stations.
  • Railway Bonds: These are put forth by the Indian Railways to gather funds to broaden and update the nation’s train networks.
  • Public Sector Unit Bonds: Various government-owned firms issue these bonds, directing funds to various projects that include constructing physical structures, energy projects, and housing. This category includes prominent organisations such as NHAI, HUDCO, NTPC, PFC, and REC.

Who Should Invest in Tax-Free Bonds?

Although there is no bar to who can and cannot invest in these bonds, a certain set of investors will benefit a lot more from investing in these bonds. Let’s take a look:

  • Those Earning a High Income: People with higher tax rates can benefit greatly from tax-free bonds because the interest income is tax-free. Compared to taxable bonds, this can result in a greater after-tax yield.
  • Traditional Investors: Individuals who prefer low-risk investments and hope to conserve capital usually find tax-free bonds attractive. Since government entities and municipalities back these, they are usually more secure, with little to no chance of default. 
  • Long-Term Investors: Tax-free bonds have long maturities. Long-term investors can lock in a consistent interest rate for many years, which can be advantageous in a dropping interest rate environment.
  • Tax Planning: Tax-free bonds can help people manage or minimise their taxable income because they give income that does not contribute to their annual taxable income.
  • Estate Planning: Investors in estate planning might utilise tax-free bonds to provide heirs with assets that generate tax-exempt income.
  • Investors Seeking Diversification: Investors who want to diversify their portfolios across asset classes can utilise tax-free bonds to include a fixed-income component with tax benefits.
  • Retiring Individuals: If you’re an investor or a retiree looking for stable income options, tax-free bonds are the right investment instruments to complement your retirement portfolio.

Advantages of Tax-Free Bonds

  • Interest Income Not Taxed: The primary draw for investors considering tax-free bonds is the absence of income tax on the interest earned. This especially benefits those in the upper tax brackets, offering a tax-efficient investment.
  • Security of Investment: Since these bonds are launched by government-affiliated agencies, the risk of default is minimal, ensuring the safety of the invested capital.
  • Consistent Revenue Stream: Investors are guaranteed a stable interest rate, translating into a reliable income, particularly suited for those who have stepped back from active employment or any individual needing a predictable inflow of funds.
  • Extended Investment Duration: The long maturity period of tax-free bonds, often between 10 to 15 years, allows for an extended duration of financial planning at a secured interest rate.

Disadvantages of Tax-Free Bonds

  • Reduced Liquidity: Unlike equities or mutual funds, tax-free bonds can be less liquid, and divesting before the term ends may result in a reduced return on investment.
  • Capped Earnings Potential: The return on tax-free bonds is fixed, which might lead to lost opportunities for higher earnings in a scenario where the interest rates climb. The fixed return can also be a double-edged sword, as the real value of the income from the bonds could diminish in the face of rising inflation, impacting the actual buying power of the returns.

Final Word

Tax-free bonds are a great way to save on paying taxes, especially if you belong to the higher income brackets. Offering stable returns and a great addition to diversifying your portfolio, it is no surprise that they are this sought after. Make informed decisions, and as always, happy investing!

Frequently Asked Questions

What should investors know about the liquidity and tenure of tax-free bonds?

Investors should be aware that tax-free bonds often come with a commitment of 10 to 20 years, and their sellability before maturity may vary, as the market for these is not always active.

How does the fixed interest rate on tax-free bonds affect investors?

A fixed interest rate, usually between 5.50% and 6.50%, offers predictable returns, ideal for those who need steady income, such as retirees.

What are the specific risks associated with tax-free bonds?

Tax-free bonds risk losing purchasing power due to inflation, and the profit from selling the bond before maturity may be taxable.

How can one calculate the yield of Tax-Free Bonds?

Yield is found by dividing the annual interest (product of coupon rate and face value) by the purchase price and multiplying by 100 for a percentage.

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Anshul Gupta

IIT Roorkee Alumnus and CFA with experience of structuring debt products worth more than 15000Cr for institutional and retail investors.

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