US savings bonds hold nest-egg interest. Better yields and state and local tax savings encourage investment
The government has used all kinds of reasons to get people to buy savings bonds. Since the Revolutionary War, appeals to patriotism have helped sell bonds to finance guns and rations. After World War II, the appeal of safety for your savings was added. Then, in 1982, the United States Treasury started paying a floating rate with a floor of 7.5 percent, so competitive yield became a new appeal.
Now, tax-filing season reminds us of one more reason: tax savings. It may seem odd that the federal government can help you cut federal taxes, yet US savings bonds contain several strategies for tax savings that should not be overlooked.
In the last year or so, however, it's interest rates that have provided the biggest appeal as savings bond sales reached record levels. In the month of January, for instance, sales hit $575 million, up 39 percent from January of 1985. That has pushed sales for fiscal year 1986 to $1.94 billion, 42 percent higher than the same period a year ago.
``The yield is the main reason,'' explains Larry Goldstein, tax manager at Arthur Young & Co., an accounting firm. ``Compared to Treasury bills, the interest rate has been very competitive.''
Under the new rules for Series EE bonds, their interest is 85 percent of the average yield on five-year marketable Treasury securities. The rate is adjusted every six months and it has continued to decline, mirroring the overall trend in interest rates. From now through the end of April, EE bonds are paying 8.36 percent, not far from 7.5 percent, which is the minimum they can pay.
``If you've shoopped around for a CD [certificate of deposit] lately, 8.36 percent is not too shabby,'' observes Thomas Hakala, director of personal financial planning at Coopers & Lybrand, another accounting firm.
At that rate, the bonds will mature, or double in value, in about nine years, faster if rates go up again. (Like a zero-coupon bond, EE bonds have no interest payments but are purchased at a discount and pay their face value at maturity.) There aren't too many places where you can double your money in nine years or so with a minimum investment of just $25. That's the price of a $50 Series EE bond. The others sell for $37.50, $50, $100, $250, $500, $2,500, and $5,000, also paying out twice those amounts at maturity.
If that isn't enough to send you to your nearest bank or thrift to buy a bond, maybe the tax angles will help.
First, while income from Series EE bonds is taxable on the federal level, it is free of state and local taxes, like all US government bonds and notes. This is of particular interest to people in high-tax states like Massachusetts, New York, New Jersey, or California.
Series EE bonds permit you to choose whether that income will be taxed every year, or when the bonds mature. Either way, you don't receive the income until maturity; if you choose the annual schedule, you just pay whatever tax may be due because of the accrued interest on the bonds.
This is good for people saving for their children's college education. ``As the law stands today, I could put the bonds in my daughter's name and have her elect to declare the income each year,'' Mr. Hakala says. ``That income will be taxable at her rate, which means she probably won't ever pay taxes on it.''
Otherwise, he notes, if the bond and its entire tax obligation came due at the same time eight or nine years from now, she might have other income, say from a summer job or a part-time job at college, which would push up her overall income enough to require tax payments on those savings bonds.
There may be a change in all this, however. Under the tax reform bill passed by the House last year, investment and savings income received by children under age 14 would be taxable at the parents' rate. This could render useless many of the tax-saving strategies that involve children, including Uniform Gift to Minors Act accounts.
Even adults can avoid a big tax bill because of maturing Series EE or the older Series E bonds. ``If you cash in the bond in the year it matures, you may have a huge bunching of income that year,'' Mr. Goldstein notes. ``To avoid that, you can convert to HH bonds.''
The Series HH bond is the only other savings bond the Treasury offers now, and the only way you can buy it is to convert, or ``roll over,'' a Series EE or some other bond. Unlike the Series EE, the HH does not have a floating rate; its rate is fixed at 7.5 percent. Also, interest in it does not build up; instead, you get a check for that interest every six months and you can keep the HH bond as long as you like, or as long as you live, letting your executor take care of the taxes.
In the meantime, you are receiving semiannual payments from the HH bonds, and only the income taken in each year is taxable. Thus, you have completely avoided the tax on the EE bonds. This strategy works especially well for retired people, because they skip the tax on the EE bonds and get the HH income when their tax brackets are probably lower than during their working years.
There is a limit on just how much tax savings you can do with savings bonds. Individuals cannot buy more than $30,000 worth of bonds a year (a $15,000 investment), although two persons listed a co-owners can double that.
If you have savings bonds, watch the calendar before you cash them in. The floating rate is adjusted each Nov. 1 and May 1, and the bonds pay whatever interest was earned up to those dates. So if you don't cash them in at these times but wait two or three months, you won't get credit for that two or three months' interest.
If you have a question that would make a good subject for this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115. No personal replies can be given by mail or phone. References to investments are not an endorsement or recommendation by this newspaper.