ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel
  • »
  • Personal Finance»
  • Understanding Finance

Zero Coupon Municipal Bonds

Updated on November 22, 2010

For investors seeking tax free investments that are safe and offer portfolio diversification, zero coupon municipal bonds may be just the right financial instrument. As the name implies zero coupon municipal bonds combine the unique no interest / high discount characteristics of a standard zero coupon bond with the tax shelter advantages offered by municipal bonds.

The basics of zero coupon municipal bonds

A zero coupon bond does not pay annual interest like a standard debenture bond. This means these bonds are highly discounted when sold. This does not mean that the holder does not pay interest taxes, however. There is a "phantom" income that is taxed in the form of imputed interest. Even though the holder receives no interest income, taxes are still paid as if he did.

Likewise, a standard municipal bond does pay annual interest and this interest is non-taxable at the federal level. It may also be tax exempt on the state and local level depending upon certain circumstances. This tax savings are the principal reason that munis are an attractive investment for many investors.

Advantages of zero coupon municipal bonds

The ability to purchase a fixed rate investment with substantial tax advantages at a highly discounted rate is very attractive and is the key advantage of zero coupon municipal bonds. A younger investor or those on a fixed income can leverage their investment dollar with these bonds. Because no interest is paid annually, the bonds are discounted highly from face value. Depending upon maturity date many of these bonds can be bought for ten or twenty cents on the dollar. To guarantee a fixed return for a low up front cost can help many people plan for the future.

These zero coupon munis also have a built in level of comfort that stocks generally cannot offer. Not only is the return safe since many municipal bonds are issued by large corporations, cities or governments, but there are many companies that evaluate and provide ratings for these bonds. Morningstar and Standard & Poore are just two companies that provide rankings for zero coupon municipal bonds.

The value guaranteed upon maturity means less stress for the investor as the market fluctuates wildly. Unless the issuer fails, the investor truly gets what he pays for. The ability to avoid temptation and play market swings means better long term result for the holder of bonds versus the stock investor.

If a holder of a zero coupon municipal bonds needs money before maturity, there are secondary markets where the bond can be sold. This is rarely a good choice, but many investors do like knowing there is a certain level of liquidity in their portfolios at all time.

Zero Coupon Municipal Bonds Considerations

Zero coupon municipal bonds can leverage cash investments
Zero coupon municipal bonds can leverage cash investments

It is always wise to speak with a municipal bond broker to learn what can go wrong in the bond market. Zero coupon municipal bonds can become problematic if the issuer fails to follow set guidelines which establish the tax status of the bonds. The purchaser in rare cases may be held responsible for taxes on what are supposed to be tax free bonds. The uncertainty of selling price if the bond has to be sold before maturity is another thing to consider. Again, most bondholders are hold-to-maturity investors unless the are buying short term Treasure bills. Education is the key just as it is with every investment type.

Zero coupon municipal bonds can be a great way to diversify and plan for retirement. The ability to leverage investment dollars in a tax exempt instrument make these bonds well worth a look. Safety and consistent yield will appeal to many older or conservative investors. A discussion with a financial advisor is a must before diving into the zero coupon municipal bonds market.

Comments

    0 of 8192 characters used
    Post Comment

    No comments yet.

    working

    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: "https://hubpages.com/privacy-policy#gdpr"

    Show Details
    Necessary
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
    Features
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Marketing
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Statistics
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)