Financial Q&A: Options few when U.S. Savings Bonds mature

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By Steve Dinnen

from the March 3, 2008 edition

Q:

Until September 2004, we could exchange Series E/EE US Savings Bonds for HH bonds, continue to defer paying tax on the accrued interest, and be paid interest biannually thereafter. However, the Treasury Department is no longer issuing HH bonds. Are there still any options to the redemption of maturing bonds that would allow continued tax deferring?

W.P., Logan, Utah

A: There are no options that would allow you to continue deferring the taxes. According to Tom Adams, author of the book "Savings Bond Advisor," when a bond stops paying interest, it's time to cash it in, hold back what you need for taxes, and reinvest the rest in a new bond or another investment.

Many people in this situation hold onto a bond rather than cashing it, hoping to continue deferring the taxes. This is a mistake, says Mr. Adams, for two reasons:

First, according to IRS rules, the tax is due in the year the bonds stop paying interest, whether you cash them in or not. You may owe a penalty and back taxes for not including the interest in your income for the year in which the bond stops paying interest.

Second, in just a few years the interest-free loan you're giving the government will cost you more than the taxes would. Either someone is going to pay the taxes eventually, or the bonds will never be cashed and the government will keep the full amount.

Ultimately, it's much better to cash the bond the moment it stops earning interest, settle up on taxes, and continue earning interest in a new investment, says Adams.