Tax-Free Bonds vs Taxable Bonds: A 2026 Comparison

You have ₹1 crore of matured FD money, a 30% tax slab, and a broker's WhatsApp forward showing an NHAI bond at 7.2% coupon labelled tax-free — followed by a government security screen showing 7.33% that will be taxed. The intuition says the tax-free bond wins. Sometimes it does. But the label conceals the two numbers that actually decide the contest: what you pay for the bond today, and what your slab really is. Get those two right and the comparison stops being a slogan and becomes arithmetic.

This post runs that arithmetic end to end: what tax-free bonds are and why you can only buy them second-hand, how their premium pricing quietly cuts the return, the taxable menu as it stands in November 2026, the breakeven formula by tax slab, and the mistakes that cost buyers real money on both sides. The general bond mechanics are in our bonds guide; the fixed-income shelf context is in our fixed income guide.

What tax-free bonds actually are

Between FY 2011-12 and FY 2015-16, government-notified PSUs — NHAI, PFC, REC, IRFC, HUDCO, NABARD, IREDA, NTPC, NHPC and a few others — raised long-term money through bonds whose interest the Income-tax Act fully exempts, under Section 10(15)(iv)(h). The coupon arrives gross: no TDS, no slab, no surcharge — you report it as exempt income and keep all of it. The issuers are infrastructure financiers with sovereign roots, and the paper is listed on NSE and BSE. Source: Section 10(15)(iv)(h), Income-tax Act, 1961 — the provision under which these bonds were notified; mechanics as summarised on SEBI-registered bond platform pages (GoldenPi tax-free bonds collection, fetched 3 November 2026).

The catch is the calendar: no fresh tax-free bond has been issued since FY 2015-16 (confirmed as of mid-2026 on platform disclosures, and no new issue has been announced). The category is a closed club. Every rupee that wants in must buy an existing bond from someone else on the exchange — at whatever price the seller demands.

You buy them at a premium — and the premium eats the exemption

Because the interest is exempt, buyers bid these bonds well above face value; most series trade at a premium to their ₹100 (or ₹1,000) face, and some trade far above it. The premium is the market capitalising the tax exemption — and it quietly does two things to your return. First, the current yield (coupon divided by price) is already lower than the coupon. Second, and worse, at maturity you receive only face value: buy at ₹124 per ₹100 face and you eat a ₹24 capital loss over the holding period, which drags the true yield-to-maturity far below the current yield.

Worked example, with the arithmetic visible. A tax-free bond with a 7.20% coupon, ten years left, quoted at ₹124 per ₹100 face. Current yield = 7.20 / 124 = 5.81% — that is the number the WhatsApp forward shows you. The true return: you pay ₹124, receive ₹7.20 a year for ten years (₹72 total) plus ₹100 at the end — ₹172 received against ₹124 paid. Solving for the rate that makes those cash flows equal gives a yield-to-maturity of roughly 4.2% a year. (Illustrative figures on a typical series — check the live YTM on any platform before buying, because every series and every quote differs.) The exemption is real; the premium bills you for it in advance.

The taxable menu, November 2026

Against that, the taxable shelf is the freshest it has been in years: the 10-year G-Sec yields about 7.33% (as on 2 November 2026, near its highest since 2022); recent 10-year SDL auctions have printed cut-offs near 8.10%; the RBI Floating Rate Savings Bond pays 8.05% for seven-year money, reset half-yearly; and AAA to A corporate bonds on SEBI-regulated platforms advertise 9-13% by rating. All of it is taxed at your slab rate — government interest with no TDS, corporate interest with 10% TDS above ₹10,000 per issuer a year — and listed bonds held over 12 months take 12.5% long-term treatment on gains. Source: yields as carried in our bonds and fixed income guides (G-Sec, SDL, FRB) and platform-advertised corporate ranges, November 2026.

Note the last row — the exemption covers interest only. Sell a tax-free bond at a profit and the gain is taxable like any listed bond's: 12.5% beyond 12 months of holding, slab before that. Source: CBDT capital-gains FAQs on the July 2024 regime; platform disclosures confirm the same treatment.

The breakeven formula: when does tax-free actually win?

One division settles it. A taxable bond's after-tax yield is its yield times (1 minus your slab). The tax-free bond wins only when its own YTM beats that after-tax number:

• 30% slab: breakeven = 7.33% × 0.7 = 5.13%. A tax-free bond must yield more than 5.13% to maturity to beat a fresh 10-year G-Sec. Our illustrative bond at 4.2% loses — despite its exempt label.
• 20% slab: breakeven = 7.33% × 0.8 = 5.86%. The exemption has to work harder; most premium-priced tax-free bonds fail here.
• 10% slab: breakeven = 7.33% × 0.9 = 6.60%. Essentially no premium tax-free bond clears this; the G-Sec wins outright.

Flip it into a price rule: for a 7.20% coupon, ten-year tax-free series, a 30% slab buyer breaks even around ₹116 per ₹100 face — above that price, the fresh G-Sec's after-tax yield wins. At a 5.13% required YTM, the bond is worth about ₹116 (ten coupons of ₹7.20 discounted at 5.13% come to ₹55, and the ₹100 face discounted to ₹61). The market sometimes quotes these bonds above their mathematical worth to a 30% buyer; the yield chase, not the exemption, does the buying. (Arithmetic illustrative; run the platform's own YTM through the same formula.)

Two refinements. First, surcharge: incomes above ₹50 lakh lose 10-15% more to tax on interest, pushing the effective slab to roughly 34-36% — which raises the taxable-equivalent hurdle and genuinely improves the tax-free case for the wealthy. Second, the comparison bond matters: against an 8.10% SDL or a 9%+ AAA corporate, the breakeven YTM for a 30% buyer rises to 5.67-6.3% — a bar most secondary tax-free bonds do not clear.

Who tax-free bonds still suit

• High-slab holders with surcharge, who face 34-36% effective taxation on interest and can find tax-free YTMs near their breakeven.
• Buyers who value the shape of the return — a gross coupon with no TDS, no slab drift, no Form 121 filings — and will hold to maturity so the capital-gains question never arises.
• Existing holders, for whom the question is moot: your bond's coupon was set at issue and the exemption travels with it; selling merely converts an exempt stream into a taxable one.

For everyone else in the 2026 market, the honest reading is that a fresh G-Sec or SDL — taxed — currently out-earns most premium-priced tax-free paper after tax, while offering more supply, better liquidity and longer maturities to choose from. The exemption was a 2013-2016 gift to that era's buyers; the secondary market's premium charges you for inheriting it.

What goes wrong, on both sides

• Buying the coupon, not the YTM. The single most common tax-free bond mistake: anchoring on 7.2-8% coupons while paying ₹115-125 per ₹100, then discovering at maturity that the return was mid-single-digit.
• Assuming the label means the category. Section 54EC capital-gains bonds (REC/PFC, five-year lock, about 5.25% interest) are not tax-free — only the capital gain is exempt, and the interest is fully taxable. PPF and SSY are fully exempt but are not bonds. The label on the WhatsApp forward is doing none of the work.
• Forgetting capital gains are taxable even on tax-free bonds. The exemption is interest-only; an early sale adds a taxable-gain event to an already premium-priced purchase.
• Ignoring liquidity. Many tax-free series trade rarely; the exit price in a thin market can subtract more than the exemption added.
• On the taxable side: forgetting TDS drag (10% above ₹10,000 per issuer until your return reconciles it) and slab creep — a promotion that lifts your slab silently changes which instrument wins.

The decision, in one line

Take the tax-free bond's YTM from the platform screen, divide it by (1 minus your slab rate), and compare that taxable-equivalent with a same-tenor G-Sec, SDL or corporate bond's YTM — then buy whichever is higher, ignoring coupons, labels and forwards. The arithmetic takes two minutes and has decided this comparison correctly for a decade.

This is educational content, not investment advice. Consult a SEBI-registered advisor for decisions specific to your situation.