Zero Coupon Bonds
As the name implies, zero-coupon bonds do not pay interest (a coupon) during the life of the bonds. Investors buy at a deep discount from the bond’s face value, which is the amount a bond is worth when it matures. Investors receive a single payment at maturity.
Zero-coupon bonds are issued from a variety of sources, including state and local government agencies, individual corporations and the U.S. Treasury. Zero-coupon bonds are subject to capital gains taxes and some require investors to pay taxes on the imputed interest each year. Zero-coupon municipal bonds and a select group of corporate-issued zero-coupon bonds, however, are tax exempt.
Who Would Want Them?
If you need a specific amount of income on a specific date in the future, zero-coupon bonds may be the perfect choice. For example, paying for a child’s college education. Purchasing zero-coupon bonds that mature on the date a child will need the money can be a convenient way to help cover the expense.
Zero-coupon bonds are also appealing for investors who wish to pass wealth on to their heirs but are concerned about income or gift taxes. If a zero-coupon bond is purchased for $800 and given away as a gift, the gift giver will have used only $800 of his or her yearly gift tax exclusion. The recipient, on the other hand, will receive significantly more than $800 when the bond matures. Similarly, tax-free zero-coupon bonds make good gifts for children who generate more than $1,800 in annual income and are subject to taxation on earnings.
Zero-coupon bonds are also an interesting option for investors with little interest in watching the financial markets move up and down. You just buy the bond and wait for it to mature.
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