When you want a consistent, stated income and low risk for your investments, bonds are a solid option. As corporate or government debt investments, bonds give holders a priority over owners of equity investments (stocks) should the issuer have serious financial problems. Investors must learn the difference between bearer bonds, which are more like cash, and registered bonds, which offer owners better protection, more like checks than cash. Few bearer bonds are still in circulation.
Whoever holds bearer bonds is treated as the owner, receiving interest payments when they are due. While they can easily be traded, even daily, they must also be carefully safeguarded since possession of the bonds is everything. Whoever holds the physical document evidencing the bond and its terms is considered the legal owner. Bearer bonds must be kept safe from loss or theft. Bearer bonds have not been issued in the United States since the Tax Equity and Fiscal Responsibility Act of 1982 was enacted.
These bonds are registered in the legal owner's name. Only the registered owner as of the interest payment date will receive the agreed upon earnings payment. Although most registered bonds are now maintained electronically, without issuing paper certificates as physical evidence, no one but the registered owner is legally entitled to the interest, regardless of the person or entity having possession of the physical bond certificate.
The classic image of wealthy people sitting around "cutting coupons" to request interest payments on their bonds has become a historical picture. However, bearer bond holders, since they are not registered owners, typically still must cut and send in the coupons attached to the few bearer bond certificates outstanding to request and receive interest payments. Registered bond owners do not need coupons, as the bond registrar or company managing these bonds has the name of the legal owners. They simply send paper or electronic checks to the owners of record at interest payment dates.
Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)
TEFRA effectively ended the future of bearer bonds. Because of the difficulty in identifying the owners of bearer bonds, the IRS had limited ability to collect amounts due from these taxpayers. There was an exception made to permit some foreign citizens to purchase bearer bonds to encourage overseas investment. The "foreign targeted obligation," better known as the "Eurobond" exemption, was revoked as of March 19, 2012.
Lost, Stolen or Destroyed Bond Certificates
Registered bonds can be replaced if a physical document is lost, destroyed or stolen since the owner's information is on file. Unfortunately, existing bearer bonds that suffer this fate cannot be replaced since there is no record of owner-identifying information. Combined with the need for physical bond certificates, bearer bond owners must provide high-level security for these documents.
Many municipalities, including states, cities, counties and towns, issue bonds to raise money for budgeted projects. In most cases, these bonds are exempt from taxation. While they typically offer lower interest rates than corporate bonds, depending on the owners' tax brackets, their effective earnings will be higher than the stated rate. Corporations and municipalities no longer issue bearer bonds because of the lack of legal proof of ownership to identify the taxpayer-owner.