Minimising taxes on bond investments

Hi all,

Not sure if this is more suited in the Investing or Taxes section, but I had a question about the bond part of my portfolio. Although the simplest here would be to buy a broad diversified ETF, I’m beginning to think this is a poor way to invest from a tax point of view. ETF average coupon rates are on the higher side since rates have gone up (because ETFs recycle bonds frequently), and since bond coupon (and corresponding ETF dividends) are taxed as income, this means we have to pay income tax on them - 40% in my case, which can eat up practically half the returns (especially for short duration bonds). On the other hand, capital gains (including from movements in interest rates) are not taxed. Therefore, if one invested in low-coupon bearing bonds, then most of the gains would be coming from pull-to-par appreciation and not from coupon payments, resulting in a much lower tax rate. Given we are just exiting a prolonged zero-interest period, there are still quite a lot of bonds that pay < 1% coupon out there, so by buying these you basically get the returns practically tax free. The disadvantage of course is the hassle of bond picking and the lack of diversification relative to a broad ETF (but you could choose a small portfolio of investment grade bonds or even just government bonds to limit the risk). There could also be liquidity risk when trying to resell the bonds if you didn’t plan to hold to maturity.

I just wanted to check I understood this properly, and whether this would be a viable strategy - also I appreciate any other warnings about this strategy that I may not have thought of.

I mostly have USD bonds in mind (because I just moved here and my savings are in USD), but the same argument applies for any currency.

Thank you!


The total return of so called “zero coupon bonds” will still be taxed [1]:

Anleihen mit überwiegender oder vollständiger Einmalverzinsung sind von der Steuerbefreiung ausgenommen. Dies gilt für Anleihen, die bereits unter pari, beispielsweise zu 80 Prozent ihres Nominalwerts ausgegeben, aber zu 100 Prozent zurückbezahlt werden. Die Rendite auf solche Zero-Bonds gilt als steuerpflichtiger Ertrag, auch wenn der Coupon bei null oder minim darüber liegt.

Translated: Bonds with predominantly or entirely single interest payments are exempt from tax. This applies to bonds that are already issued below par, for example at 80 percent of their nominal value, but are repaid at 100 percent. The yield on such zero bonds is considered taxable income, even if the coupon is zero or slightly higher.

Another often discussed alternative is the BOXX ETF [2]. There they don’t directly invest into bonds, but through options, so the return is considered tax free in Switzerland [3]. Yield is >5%:

(zu verseuernder Ertrag → taxable value = 0)

Some more discussion on Reddit [4]

[1] Wie mit Anleihen doch noch etwas verdient werden kann | cash
[2] BOXX - Alpha Architect ETFs
[3] ICTax - Income & Capital Taxes
[4] Tax optimized T-bill return ETF: BOXX : SwissPersonalFinance


From a tax POV, the best bonds are indeed the ones that were emitted at 100% with a very low coupon (but higher than 0%). As you mentioned, there are currently indeed a lot of such bonds that allow you to get a significant part of the overall yield (in extreme cases almost everything when they e.g. have a 0.05% coupon) tax-free.

Your thinking is more or less correct. If you are okay with effort to find the lower coupon bonds, then you can minimise taxes

However I would suggest to focus on bonds which were issued with close to 100 USD and not the ones which were issued at higher discount. Discounted bonds are taxed for the whole gain (sell price -buy price)

Be prepared to do the tax calculations though. Most of the ISINs might not be on ICTAx.

Since you just moved here, just to mention you should consider how best to use your 2nd 3rd pillar

If you are in employment you will have a 2nd pillar pension fund. Some people consider this as bond-like and as a tax efficient alternative to buying bonds. I have found I stay close to the “your bond % should be your age” rule of thumb without buying any bonds outside of 2nd pillar. Employer and employee contributions increase with age, by law

You can top up 2nd pillar with voluntary contributions which are tax deductible. It can make sense to do this in your peak earning years when your tax rate is highest, it sounds like this is your case.

If you still feel you need more bonds to reach your allocation consider using 3 pillar since interest accrues free of tax inside the wrapper

2 and 3 pillar are both taxable on withdrawal at special rates in Switzerland, which are much lower than your current 40%. However plan ahead if you may retire to another country since if not careful the withdrawal may be taxable in the destination country and rates are usually higher than CH

Regards currency, it is often considered that a role of bonds is to reduce risk so currency should match your spending. So if you plan to retire in US then USD bonds make sense

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Thanks everyone, this confirms what I was thinking. To be clear, I was not talking about zero bonds “that are already issued below par, for example at 80 percent of their nominal value”, but regular bonds issued at par which today trade much below par by virtue of higher interest rates. A random example of a treasury, United States of America 0,25% 20/25 Bond | A280RV | US91282CAB72 | Price there are many others of various maturities as well as corporates.

I had never heard of BOXX - fascinating! Could consider it to park some cash but I’m a bit hesitant to put large amounts in it. It sounds safe since the options look exchange traded… but it seems a bit of a case of “you don’t know what you don’t know” when thinking about what’s going on behind the scenes.

Thanks for the advice on the two pillars. Last year I maxed out the voluntary contributions of the 2nd and 3rd pillars, and will probably continue doing so, but I actually have them all in stock to the extent that I control it (I have a 1e plan which is quite flexible). I didn’t really think about doing the opposite, will consider it. In any case, I’m in my mid-forties so even the “rule of thumb” suggests almost half my wealth in bonds, more than what would be in the pillars. I don’t have nearly enough money to retire in Switzerland, but I could probably just about manage it in a cheaper European country. So I’m quite risk averse and large drawdowns are really not something I want to live with right now.

As for my “base currency”, this always bugs me because I don’t really know where I will end up. I’ve lived with EUR/USD/GBP/HKD but don’t really have a home country. I’m likely to end up somewhere in Europe though (Switzerland itself would be nice, but then I’d probably have to work another 10-20 years, and I don’t want to…), unlikely in the US. So yeah, you are absolutely right: I have an excess of USD that I would like to convert or at least diversify away from, but the timing right now seems really bad as US is ahead of the cuvre in lowering rates and the USD is weak. I’m hoping things will equalise in the next year, but that in itself is a gamble. Debt ceiling woes keep me up at night each time.

Thanks everyone for you insights!

One more question about holding single US bonds: are these subject to estate tax in a similar way to stocks? I was sure the answer would be “yes”, but various sites suggest that the answer is in fact “no”. Estate tax seems to be on US-situated assets only, which includes stocks of US corporations but not bonds. I didn’t find any direct reference for treasuries either. Can someone confirm?

You would be betting against the market which expects USD to weaken vs. CHF in the next year. Search “USDCHF futures” to see the predicted rates

Interest parity theory implies that if there is an opportunity to make profit, banks would borrow in CHF to invest in USD until the FX rate and interest rates move and the arbitrage opportunity closes

Note USD has also strengthened by about 4 cents since the start of the year