Zero-Coupon Bonds

Zero-coupon bonds are a discounted form of the more traditional type of bond. They can often be purchased at a price significantly lower than the security's face value. In return, the issuer of the security does not make interest payments throughout the security's life but, at the date of maturity, combines the compounded interest accrued with the original principal to pay the investor the full face value amount of the bond. In contrast to more traditional investments, zero-coupon securities are characterized by the initial discounted purchase, compounded interest that accrues over the full life of the bond rather than periodic payments, and payment of the full face value at the security's date of maturity.

Examples of zero-coupon bonds include U.S. Treasury bills and U.S. savings bonds.

Taxation of Zero-Coupon Bonds

With zero-coupon bonds, you do not receive any interest payments until the date of bond maturity. The Internal Revenue Service, however, taxes the assumed interest payments on the bond each year rather than deferring tax payment until the bond value is realized at maturity. Therefore, zero-coupon bond holders are responsible for the implied annual interest of their investment that they will receive when the bond matures. The exception to this exists in any tax-deferred account, such as in retirement accounts, where the account holder is relieved of any tax obligations.

Keep learning about bond investing:

Bonds involve risks including, but not limited to interest rate risk, reinvestment risk, inflation risk, call risk, liquidity risk, credit risk, market risk, default risk, event risk and a risk of loss of principal. New issue offerings are sold by prospectus or offering circular available at www.scottrade.com. Investors should read these carefully.

The material provided in this presentation is for informational purposes only and its use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security, type of security, or pursue a specific strategy. Investors should fully research any security or strategy before making an investment decision.

Scottrade does not provide tax advice. The material provided in this article is for informational purposes only and Scottrade is not responsible for any errors or omissions. Contribution and income limits are subject to change without notice. Please consult your tax, or legal, advisor for questions concerning your personal tax or financial situation.

The information and content provided in the Scottrade® Knowledge Center is for informational and/or educational purposes only. The information presented or discussed is not, and should not be considered, a recommendation or an offer of, or solicitation of an offer by, Scottrade or its affiliates to buy, sell or hold any security or other financial product or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances and your investment objectives. Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.