What Are Treasury STRIPS?

Table of Contents

What Are Treasury STRIPS?

Let me explain Treasury STRIPS to you directly: these are zero-coupon bonds backed by the government, sold at a discount so you get the full face value when they mature. You won't see regular interest payments like with typical bonds; your return comes purely from the gap between what you pay and what you receive at the end. They're created by separating coupon payments from bonds, allowing those parts to trade on their own, which gives you more options for investing. Since starting in 1985, they've been useful for long-term planning, and now they cover a wider range of Treasury securities.

Key Takeaways

Here's what you need to know upfront: Treasury STRIPS function as zero-coupon bonds you buy at a discount, delivering the full face value at maturity. They're supported by the U.S. government, which means top-tier credit quality and safety for your money. You have to get them through financial institutions or brokers since they're traded on the secondary market. The program kicked off in 1985, starting with 10-year securities and expanding to all Treasury notes and bonds by 1997. Even without cash interest payouts, you're taxed on the interest annually, but you can defer that in accounts like IRAs.

How Treasury STRIPS Work

You should understand the mechanics: Treasury STRIPS come from stripping a bond's coupons away from the principal. The stripped bond sells to you at a discount, and your profit is just the difference between that price and the face value when it matures. Those coupons turn into their own investments, sold separately. Issued by the U.S. Treasury and backed by the government, they replaced older zero-coupon options like TIGRs and CATS starting in 1985. Remember, you can't buy them straight from the government; brokers handle the sales to investors like you.

The Evolution of Treasury STRIPS

Let me walk you through how these evolved: the original STRIPS from 1961 were bundles of re-opened bills maturing over weeks, but they got phased out by 1974. After tax law changes, a new version launched in 1985, letting bonds over ten years get split into principal and coupon payments for separate trading. By 1986, the Treasury added a way to recombine them back into original securities. Popularity grew, so eligibility expanded—by 1997, it covered all Treasury notes and bonds, and in 2000, even 5-year notes joined in.

Fast Fact

Just so you know, the first STRIPS appeared in 1961 but were discontinued; the ones available today started in 1985.

The Process of Coupon Stripping

Coupon stripping is straightforward: it detaches interest payments from the bond, turning them into separate securities with the principal due at maturity. No payments happen in between. Take a 10-year bond with a $40,000 face value and 5% annual interest paid semi-annually—it can create 21 zero-coupon bonds: 20 from the coupons and one from the principal. Each coupon strip has a $1,000 face value, and all these pieces trade independently in the market.

Benefits of Investing in Treasury STRIPS

You get real advantages with STRIPS: like all Treasury securities, they're backed by the U.S. government's full faith and credit, so default risk is minimal, making them ideal if safety is your priority. They're simple, with clear costs and payoffs, and a variety of maturity dates lets you pick one that matches when you'll need the cash for your goals. The entry cost is low—while full bonds might start at $10,000, a STRIP from interest could be just a few hundred dollars. Plus, there's an active secondary market, and it's easy to hold them in tax-advantaged retirement accounts.

Why Treasury STRIPS Are Popular

STRIPS appeal to fixed-income investors for good reasons: their high credit quality comes from U.S. Treasury backing, and since they're discounted, you don't need much cash upfront. If you hold to maturity, you know exactly what you'll get. They offer various maturity dates based on interest payment schedules, and the secondary market is strong, so you can sell early if needed with decent liquidity.

Important Note

Keep this in mind: the secondary market for Treasury STRIPS is robust, with individual ones trading at market value until maturity.

Tax Implications of Treasury STRIPS Investments

On taxes, you generally owe on the interest earned each year, even without cash coming in until maturity or sale. But you can delay that tax in a deferred account like an IRA. You'll get a report showing your taxable interest income as a holder.

The Bottom Line

To wrap this up, Treasury STRIPS—Separate Trading of Registered Interest and Principal of Securities—give you a secure option backed by the U.S. government. As zero-coupon bonds bought at a discount, they deliver a set payoff at maturity, perfect for targeting specific financial needs. You can only get them through institutions or brokers, but their simplicity and maturity options provide flexibility. Factor in taxes if not using a tax-advantaged account; overall, they're a solid pick for safe, predictable returns.

What Are Treasury STRIPS?

Highlights