Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
If you include short term (1 year or less) zero coupon CDs, I used these when CD rates were better than T-bills (after tax).
Assuming that you hold the CD to maturity, conceptually a zero coupon CD is no different from a CD that accrues interest but pays it all at maturity.
For example, consider a 1 year CD with an APY of 4.0%. If you invest $1000, then at the end of the 12 months you get $1,040 including interest. The coupon (interest) frequency doesn't matter assuming you don't withdraw the interest. All that matters is that 4.0% APY. It's just as if you purchased a 1 year zero coupon CD with a face value of $1,040 at the discounted price of $1,000.
---
For tax purposes, if a CD matures in 12 months or less, it does matter whether it pays interest periodically or just at maturity. You owe taxes on interest as it is paid, even if you reinvest. So it is preferable that the CD not pay accrued interest until maturity. It doesn't matter whether you call this a discounted zero coupon CD or simply a CD that pays interest at maturity.
However, if a CD maturity is longer than a year (and it doesn't pay accrued interest more frequently than annually), then it is taxed as if it paid accrued interest yearly. Even if it doesn't pay out accrued interest until maturity.
Short-Term: Interest earned on CDs with terms of one year or less is considered taxable income in the year that the CD interest is paid out.
Long-Term: CDs with terms over a year are taxed as interest is earned over the CD term. Interest is considered taxable income in the year that you are legally entitled to it. For example, if you have a CD with a term of five years, you will owe tax on the interest paid in each of the years that you hold the CD before maturity.
@Old_Joe & @msf I came across Zero coupon CDs last night at Schwab, while checking rates. First thing that crossed my mind was this a new type of CDs or something that I just passed over? Wikipedia filled in the info. Thanks for filling in more of the blanks. I checked Vanguard & was (shocked) at the lack of bank CDs! Also I couldn't find any info on Zero CD's. Guessing they don't offer them.
I set no restrictions on the search (i.e. secondary market included), except for "best offer only" and maturities from 0 months to 30+ years. I then sorted on coupon (smallest first). There were no CDs with 0.00% coupons. The smallest coupon shown was 0.25%.
When restricting to new issues, all of the CDs offered by Schwab are priced at 100 (par) and pay coupons a bit north of 4%. Many of the short term (12 months or less) CDs are shown by Schwab to pay their coupon "at maturity". As I explained above, you can call those zeros if you wish.
@msf It's hard to believe there would be that much difference between Sunday night & Monday morning!! Last night VG showed 3 or 4 bank cd's. Seems I forgot to mention what I was looking at: 18 month non callable. That has remained.
Rechecked Schwab 18 month cds, list of4 or 5 banks cds now. I see NO zero coupon listed.
@Old_Joe Did you happen to check rates at Schwab last night. The page I was looking at had 20 or more cds listed. Would bombing by US caused this list to vanish, be pulled. I don't have an answers.
@Derf, I checked Schwab Bonds & Fixed Income screens.
For CDs, shown are those that pay interest only on maturity (i.e. interest is accumulated). These effectively act like zeros. I didn't see any click for CD-zeros.
For all bonds except Treasuries, there a selection near the bottom where you can click Zero Coupon.
For Treasuries, there are separate tabs for regular Treasuries and Treasuries Zeros. This is because most zeros are Treasury zeros.
There are Treasury STRIPS that involve coupon stripping. For example, take a 30-yr Treasury bond and split it into 2 x 30 = 60 coupon payments and 1 principal payment. So, now there are 61 ZERO-COUPON bonds that can trade by themselves. Treasury issues are huge, so these pieces are also large, with the principal payment part being the largest.
Comments
OJ
Assuming that you hold the CD to maturity, conceptually a zero coupon CD is no different from a CD that accrues interest but pays it all at maturity.
For example, consider a 1 year CD with an APY of 4.0%. If you invest $1000, then at the end of the 12 months you get $1,040 including interest. The coupon (interest) frequency doesn't matter assuming you don't withdraw the interest. All that matters is that 4.0% APY. It's just as if you purchased a 1 year zero coupon CD with a face value of $1,040 at the discounted price of $1,000.
---
For tax purposes, if a CD matures in 12 months or less, it does matter whether it pays interest periodically or just at maturity. You owe taxes on interest as it is paid, even if you reinvest. So it is preferable that the CD not pay accrued interest until maturity. It doesn't matter whether you call this a discounted zero coupon CD or simply a CD that pays interest at maturity.
However, if a CD maturity is longer than a year (and it doesn't pay accrued interest more frequently than annually), then it is taxed as if it paid accrued interest yearly. Even if it doesn't pay out accrued interest until maturity. https://www.seattlebank.com/about/updates/updates-detail.html?cId=84542&title=understanding-tax-implications-of-certificates-of-deposit
Zero coupon CDs, like zero coupon bonds, are taxed on their annual accrued interest (imputed interest, aka phantom income).
Thanks for filling in more of the blanks.
I checked Vanguard & was (shocked) at the lack of bank CDs! Also I couldn't find any info on Zero CD's. Guessing they don't offer them.
https://client.schwab.com/Areas/Trade/FixedIncomeSearch/FISearch.aspx/CDs
I set no restrictions on the search (i.e. secondary market included), except for "best offer only" and maturities from 0 months to 30+ years. I then sorted on coupon (smallest first). There were no CDs with 0.00% coupons. The smallest coupon shown was 0.25%.
When restricting to new issues, all of the CDs offered by Schwab are priced at 100 (par) and pay coupons a bit north of 4%. Many of the short term (12 months or less) CDs are shown by Schwab to pay their coupon "at maturity". As I explained above, you can call those zeros if you wish.
To see the same thing at Vanguard, go to its fixed income search page (no login required) and click on the CD tab.
https://fixed-income-trading.web.vanguard.com/
Go to "advanced search" and for "payment frequency" select "interest at maturity". You may as well select the "new issue" checkbox as well.
Vanguard reports 39 bank CDs that pay interest at maturity.
Rechecked Schwab 18 month cds, list of4 or 5 banks cds now. I see NO zero coupon listed.
@Old_Joe Did you happen to check rates at Schwab last night. The page I was looking at had 20 or more cds listed.
Would bombing by US caused this list to vanish, be pulled.
I don't have an answers.
For CDs, shown are those that pay interest only on maturity (i.e. interest is accumulated). These effectively act like zeros. I didn't see any click for CD-zeros.
For all bonds except Treasuries, there a selection near the bottom where you can click Zero Coupon.
For Treasuries, there are separate tabs for regular Treasuries and Treasuries Zeros. This is because most zeros are Treasury zeros.
There are Treasury STRIPS that involve coupon stripping. For example, take a 30-yr Treasury bond and split it into 2 x 30 = 60 coupon payments and 1 principal payment. So, now there are 61 ZERO-COUPON bonds that can trade by themselves. Treasury issues are huge, so these pieces are also large, with the principal payment part being the largest.