Difference between tax free bonds and tax saving bonds

There are many investment options in the market. Each option has its own distinct characteristics. If one is to provide tax benefits, one returns at a higher rate. There is a lot of risk when investing in someone, then there is little to no risk. Some have high liquidity, in some the amount is locked for a certain period. Despite having different types of investment options, the general investors prefer the government-backed options. A similar option is a bond and most people consider tax-free bonds (tax-free bonds) and tax-saving bonds (tax-saving bonds) to be almost identical, but in reality the two are quite different. Hence the difference between the two is being explained through this article.

Why does the government provide tax benefits on bonds?

Infrastructure projects at top institutions such as PFC and REC require money. The government offers investors tax-free bonds to invest in these projects. An investor can get tax benefits by investing in tax free bonds. Because of this, the investor invests money in projects, which strengthens the economy and leads to growth.

Tax free bond

These are bonds that, when purchased, the income generated through interest is completely tax free. These bonds are issued by government entities or government-backed entities. Government has a stake in these institutions. The risk of default in these bonds is minimal or there is little credit risk. The duration of tax free bonds is very long, ranging from 10-20 years. Therefore, you should invest in tax free bonds only if you can stay invested for a long period. The most popular tax free bonds are municipal bonds. These offer fixed interest. This is a very low risk investment. Investments in these are tax-exempt under Section 10 of the Income Tax Act. The money received through tax free bonds is used to boost infrastructure in the economy.

Who can invest in tax free bonds?

Those who want a stable and fixed income like senior citizens can choose to invest in tax free bonds. The risk of defaults is negligible and has a longer duration. These are an excellent investment option for investors falling in high tax slabs such as HNIs and film stars. Investors with the ability to stay invested for long periods can also invest in tax free bonds.

Features of tax free bonds

Tax free bonds have many characteristics, some of which are –

  • Income received as interest is tax free. There is no TDS on these bonds. They are more tax-efficient than FDs.
  • Credit risk is very low.
  • It is not easy to liquidate these bonds. These bonds have a longer duration.
  • Their lock-in period is 10–20 years.
  • The returns from them depend on the purchase price.
  • Interest rates range from 5.5–6.5% per year.

Tax saving bond

Tax saving bonds provide tax benefits on the amount you invest. Interest earned through investment in these bonds is taxable.

  • Investing in tax saving bonds provides additional tax benefit under Section 80 CCF of the Income Tax Act. An investor can claim a tax deduction of up to Rs 20,000 per year if invested in them. This means that the investor can reduce his taxable income by up to Rs 20,000 by investing in these bonds.
  • Experts consider it an ideal investment option for conservative investors who want to invest with less risk. However, the return on investment in tax saving bonds is lower as compared to other investment options, as they also have lower risk as compared to other options. For those seeking short-term returns, investing in it is not right.

Comparison of tax saving and tax free bonds

  • Tax-free bonds offer slightly higher interest rates than tax-saving bonds. Investors can invest up to Rs 5 lakh in tax free bonds. Tax-free bonds are usually long-term investment options with a duration of up to 20 years.
  • Tax saving bonds and tax free bonds are two different types of investment options. Investors in a tax saving bond can receive tax benefits on the principal amount invested, while interest earned in a tax free bond is completely tax free.