Definition: An accrual bond is more commonly referred to as a zero coupon bond. It is a type of bond where interest is added to the principal balance due to the bondholder at maturity and not paid out in cash. The bond is sold at a discount to its maturity value based on a financial calculation that will yield a specific amount. Savings bonds are a popular form of the accrual bond or zero coupon bond.
One of the biggest dangers of the accrual bond or zero coupon bond is phantom income. Even though you receive no income in cash each year, you are still required to pay taxes on the interest that was credited to the value of your bond. If you have a good sized fixed income portfolio with several hundred thousand dollars invested in accrual bonds, you could find yourself owing taxes that you cannot pay.
