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Zero Coupon Bonds

Zeros, as zero coupon bonds are called, get their name from the process of stripping the income from the bond. That might sound peculiar, but if you think about it, a bond is two parts: one part principal and one part interest. Zero coupon bonds are either issued at a discount (like Treasury bills) when they are purchased since they pay no interest or packaged as traditional bonds. A financial institution will split the interest and principal and repackage them separately, with the principal piece being the zero coupon bond.

Key Point

Zero coupon bonds are purchased at a discount, but you'll pay taxes on the interest each year you own them just as if you had received the interest. Your best bet is to keep these in a qualified retirement plan where you won't have to pay current taxes.



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