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If you’ve browsed fixed-income options recently, you’ve probably noticed something strange: searches show tax-free bonds, but there are no new issuances. No new tax-free bonds have been released since FY 2015-16. While older bonds from PSUs continue to be circulated, the only way to acquire new tax-free bonds is to purchase them from other investors on the stock exchange.
This leads us to the queries this article aims to answer: Will tax-free bonds still have a place in a balanced investment portfolio in 2026, given that their yields have decreased, the taxation structure has changed, and for which investors?
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What Are Tax-Free Bonds and Why Do They Still Exist in 2026
Also known as Section 10(15) bonds, these are offered by central government-notified Public Sector Undertakings (PSUs) like NHAI, REC, PFC, IRFC, HUDCO, and NABARD. With tax-free bonds, the coupon payment is entirely tax-exempt, and there is no tax deduction at source (TDS), as is the case with regular bonds, where the interest is added to your income and is taxed according to the applicable slab rate.
Current Yields: What You’re Actually Getting in 2026
Currently, tax-free bonds in the secondary market are yielding somewhere between 4.5% and 6.5% in 2026, depending on the bond issuer and the time left until maturity. These yields might seem unappealing compared to AAA bonds or fixed deposits offering 8-8.5%, that is, until you factor in what actually ends up in your bank account after you pay taxes.
The reason tax-free bonds can compete with higher-coupon taxable instruments is simple: A 6% tax-free yield remains 6% post-tax, versus an 8.5% taxable yield, which is subject to taxation every year. Whether this works in your favor depends on your tax bracket. This is why the comparison below is the relevant figure to consider as opposed to any headline coupon rate.
Post-Tax Yield Comparison Across Tax Slabs
| Instrument | Coupon/Yield (Illustrative) | Post-Tax Yield (5% slab*) | Post-Tax Yield (20% slab*) | Post-Tax Yield (30% slab*) |
| Tax-free bond | 6.0% | 6.0% | 6.0% | 6.0% |
| AAA corporate bond | 8.5% | 8.06% | 6.73% | 5.85% |
| Bank FD | 7.5% | 7.11% | 5.94% | 5.16% |
*Effective rates include 4% cess (5.2%, 20.8%, and 31.2%, respectively); the surcharge for very high incomes isn’t factored in and would widen the tax-free-bond advantage further.
At the 5% tax slab, there is no reason for holding a tax-free bond. Even with post-tax calculations, both taxable options are still better. At the 20% tax slab, the tax-free bond is slightly better than a fixed deposit, though still behind a AAA corporate bond. The 30% tax slab is the only instance when the tax-free bond is more beneficial than the other options, post-tax.
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The Catch: Tax-Free Bonds Trading at a Premium in 2026
Most tax-free bonds trading in 2026 are above face value because the coupon rates are from 2012-2015 and, at 6.5%-8.5%, are higher than the current market rates. Here’s how buying at a premium can be a bad bet:
- Your running yield (the return you actually receive because you are paying more than the bond’s value) will actually be less than the coupon rate because you bought it at a premium.
- Additionally, you will realize a capital loss at maturity. For example, you buy it at ₹1,200 and will redeem it at its ₹1,000 face value.
- That capital loss can be offset against other capital gains, so you still retain some benefit.
- In the highest tax bracket, you still receive a better return than the taxable options, even after the premium.
What Happens If You Sell Before Maturity
While the interest is tax-free, the capital gain on the sale is taxable. For listed bonds, 12 months is the threshold for long-term status. Changes after Budget 2024 have also changed the taxation of bonds: Long-term capital gains on listed bonds are now taxed at a flat rate of 12.5% with no indexation, and short-term capital gains are taxed at the slab rate if the bonds are held for 12 months or less.
Who Should Consider Them in 2026
- 30% tax slab: Tax-free bonds are better than bank FDs (fixed deposit) and even AAA-rated bonds
- 20% – 25% tax slab: Comparable to bank FDs, but it may not be so with high-yield taxable corporate bonds
- Retirees looking for a safe, predictable, tax-exempt income, and no reinvestment risk
- NRIs and HUFs are often eligible but under-allocated to this space
- Investors who can hold until maturity, since they have relatively low liquidity and premium pricing might diminish returns if sold before maturity
Investors in the 5–10% slabs should skip, because taxable alternatives clearly win post-tax, along with anyone needing high liquidity.
Tax-Free Bonds: Frequently Asked Questions
Tax-free bonds are issued by specified government-sponsored entities. These bonds are not subject to income tax as per the relevant provisions of the Income Tax Act.
As of 2026, there are no fresh issuances of tax-free bonds. Investors can, however, buy previously issued tax-free bonds through the secondary market if they are available.
The interest earned is tax-free, but capital gains tax may apply if you sell the bonds in the secondary market at a profit before maturity, depending on the applicable tax rules.
No investment can be termed completely risk-free. However, most tax-free bonds are issued by government-backed entities and are considered less risky compared to most corporate bonds.
Since there are no new issuances, investors can purchase listed tax-free bonds through the secondary market using a demat and trading account or via a SEBI-registered Online Bond Platform.
Disclaimer
Fixed returns do not constitute guaranteed or assured returns. Investments in corporate debt securities and municipal debt securities/securitized debt instruments are subject to credit risks, market risks, and default risks, including delay and/or default in payment. Read all the offer-related documents carefully. This blog/article should not be construed as financial advice or as an offer or recommendation to buy or sell any security or any products/services of/on GoldenPi or any product/services of its third-party client(s). For a detailed calculation of YTM, visit our website. T&C’s Apply.
