A Zero-Coupon Treasury is a U.S. government bond that does not pay periodic interest and is sold at a discount to its face value, maturing at par.
A Zero-Coupon Treasury is a type of U.S. government debt security that does not offer regular interest payments (coupons) like traditional bonds. Instead, it is sold at a significant discount to its face (par) value and pays the full par amount upon maturity. The difference between the purchase price and the maturity value represents the investor's return. These securities are generally considered low-risk investments because they are backed by the full faith and credit of the U.S. government. Their maturity range can vary from short-term to 30 years, offering a range of options for duration-sensitive investors. Since they don't provide income during their term, these instruments are particularly appealing to investors who don't need immediate cash flow. The values of Zero-Coupon Treasuries are highly sensitive to changes in interest rates due to their duration and the lack of intermediate payments. As such, they are commonly used for long-term financial goals, such as education savings or future liabilities, where a lump-sum payout at a specific date is desired.
Zero-Coupon Treasuries align closely with the needs of long-term capital planning—particularly for future liabilities such as trusts or legacy transfers. Their predictable, lump-sum maturity value makes them useful tools for asset-liability matching and interest rate risk management. Additionally, family offices benefit from their tax-deferral potential in tax-deferred accounts and the ability to structure portfolios with known cash flow timelines. However, careful tax planning is required in taxable accounts due to phantom income taxation on accrued interest, even though no cash is received until maturity.
Suppose a family office purchases a 10-year Zero-Coupon Treasury with a face value of $100,000 for $61,000. No interest payments are made during the decade, but at maturity, the U.S. government repays the full $100,000. The $39,000 gain represents the implied interest earned over the life of the bond. Even though no cash is received annually, the office must account for and pay taxes on the annual accrual (imputed interest) if held in a taxable account.
Zero-Coupon Treasury vs. Traditional Treasury Bond
While both are U.S. government securities, a traditional Treasury bond pays semiannual interest and returns principal at maturity, whereas a Zero-Coupon Treasury does not pay periodic interest but accrues value over time and pays the full amount at maturity. The former offers periodic income, while the latter offers a predictable, all-at-once return.
Are Zero-Coupon Treasuries completely tax-free?
No. While they are exempt from state and local taxes, Zero-Coupon Treasuries are subject to federal taxation. Investors owe tax annually on the imputed interest, even though no interest payments are received during the bond’s life.
Can Zero-Coupon Treasuries be used in retirement accounts?
Yes. Zero-Coupon Treasuries are ideal for tax-deferred accounts like IRAs or pension plans because the imputed interest is not taxed annually. Taxes are deferred until distributions are made from the retirement account.
Why are Zero-Coupon Treasuries more sensitive to interest rates?
Because they have no interim cash flows, their entire return is realized at maturity. This structure makes them have longer durations relative to coupon-bearing bonds, increasing their price sensitivity to changes in interest rates.
