Looking for a Relatively Safe Tax-Free Investment? Consider Zero-Coupon Municipal Bonds.

Looking for a Relatively Safe Tax-Free Investment? Consider Zero-Coupon Municipal Bonds.

Zero-coupon municipal bonds are sold at a substantial discount from face value, and the interest is often tax-free.

One form of municipal bonds which is especially attractive to those holders who require appreciation of their investment, but do not require immediate income is zero coupon municipal bonds. While most municipal bonds provide semi-annual interest payments, zero-coupon bonds do not bear interest. The term “coupon” refers to interest. While these bonds do not bear interest, they are issued at a substantial discount from face amount and the bond holder will be paid the face amount at the bond maturity.
 
For example, if you purchase a $20,000 face value zero-coupon bond that is redeemable in 20 years with a 5.5% interest rate compounding semi-annually, you would pay only approximately $6,757 for the bond when originally purchased. At the end of 20 years, you would get $20,000.
 
There are several important benefits of zero-coupon municipal bonds; one of the most important is the fact that interest paid by zero-coupon municipal bonds is often tax-exempt. This often gives the investor much higher returns than comparable taxable securities. In the above example, the investor would receive $13,243 in tax-exempt interest income. Zero-coupon municipal bonds also require a lower initial investment than many other types of investments (most are sold in denominations of $5,000) and the investor will know exactly how much money they will receive on a future date, allowing them to plan their future more effectively. These bonds also protect the investor from reinvestment risk: they will be able to lock in a particular interest rate for the long-term, without having to worry about market fluctuations.
 
Due to the current economic climate in many municipalities, there are some debates about the safety of municipal bonds, which are addressed the Best Cash Cow article located here. Even with an unstable economy, however, municipal bonds remain one of the safest investments a person can make.
 
If you are considering a bond fund, you should first be aware of separate debates surrounding bond fund performance and tax treatments for swap agreements. Some of the income from bond funds may be taxable. Many experts advise that a simple portfolio of municipals and TIPS (Treasury Inflation-[protected Securities) are best. Investors can purchase and hold bonds directly from either the government or a brokerage.
 
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