Question: I am about to make an IRA investment in the Zero-Coupon-Bond Corporate Trust Fund. Can you give me your opinion on this kind of fund? Is it safe? This fund offers about 25 percent return.
Answer: I don't recall talking about zero-coupon bonds before, so if you don't mind I'll explain them to other readers before I answer your question.
A zero-coupon bond pays no current interest during its lifetime. Instead, you buy the bond at a substanital disount, then receive the full face value at maturity (similar to a Series EE savings bond).
A majar advantage as a vehicle for an Individual Retirement Account is that the original yield is good until maturity. No rollover is needed during the life of the investment; nor do you need to look for a place to invest the interest payments (perhaps at a lower yield) because there aren't any.
A disadvantage of zero-coupon bonds as regular (that is, non-IRA) investment is that you must report as interest income, and pay tax on, the annual pro rata share of the eventual payoff, even though you receive no cash until maturity.
But this disadvantage doesn't apply to an IRA (or Keogh) because tax liability on interim earnings is deferred anyway, until you withdraw funds after retirement.
(The advantage to the issuing corporation, incidentally, is the other side of this coin. The company makes no cash payment of interest until the bond matures, but is permitted to claim as an expense the annual pro rata share of the eventual payout.)
This is a pretty good place to put your IRA money, particularly if you think interest rates will go down over the long term. And although there is no federal guarantee, I believe they're quite safe if you pick a good sponsor.
But 25 percent? I know of no zero-coupon bond or unit trust offering that kind of yield. As this is written (early July) the yield on zero-coupons is in the 13-to-15 percent range.
You may be confusing the yield with the cost. An intermediate-term (around 10-year) zero-coupon bond offering a 14 percent yield to maturity would cost around 25 cents on the dollar, or 25 percent of face (maturity) value. Talk to the sales representative again, or take a good look at the prospectus.
Q: Please explain in detail the attached item. I can't understand the impact of the loss. (Attached was the column for June 28 about corporate payroll deduction plans for IRA, in which I said that a disadvantage was loss of "the tax benefit that would be available if you were to deposit the entire amount of your annual contribution early in the year.")
A: The key to the disadvantage is the potential tax benefit that results from early deposit of IRA funds. As soon as you make an investment in your IRA, income tax is deferred until withdrawal on all subsequent earnings.
So if you make your deposit for 1982 in January of this year rather than waiting until, say, January 1983, you get the benefit of tax deferral for a full year's earnings.
Since a payroll deduction plan spreads the IRA investment over the entire year, you don't get a full year's worth of deferral on the total amount invested.
The ease and simplicity of payroll deduction may well compensate for giving up tax deferral on a relatively small chunk of earnings. But knowledge is essential to making an informed decision--and I was trying to contribute to your store of knowledge.
Q: I am a total disability retiree from federal civil service. I haven't yet reached 65 so have not yet begun to recover my contributions to the federal retirement system. Since my disability payments are now considered a continuation of earnings rather than a retirement pension, can I quality for an IRA?
A: Sorry, you can't. Although disability payments are considered wages or salary for some purposes, they are not earned income for IRA eleigibility. (But by the same reasoning, you are eligible for a spousal IRA if your spouse is employed.)