Now's the time to rummage through attic trunks and safe deposit boxes for old E-bonds. Effective May 1, 1981, interest rates payable on United States Savings Bonds are 8 1/2 percent for HH-bonds and up to 9 percent for EE-bonds when held to maturity.
THe new rates come along at a time when old E-bonds are maturing after 40 years. When E-bonds purchased in 1941 reach extended maturity in 1981, you should either redeem them for cash or exchange them for HH-bonds for a very good reason -- they will no longer accumulate interest.
These old bonds are worth a lot today. One $25 E-bond purchased originally in 1941 for $18.75 will be redeemed on its anniversary month in 1981 for $73.01, for a 389 percent increase. Unfortunately, the gain will not be taxed a long-term capital gain rates. All of the increase will be taxed as ordinary income.
But you have two options -- noted earlier in "Moneywise" columns:
1. you may exchange the E-bonds for HH-bonds and defer any tax on the accumulated interest until later when the HH-bonds are sold or mature without extension. You will earn the new 8 1/2-percent rate on the full maturity value of the E-bonds.
2. You may cash in the E-bonds, pay taxes on the interest portion only, and invest the remaining cash in some other income- producing asset.
These are not new options, but the higher 8 1/2-percent interest rate payable on HH- bonds could affect your strategy. One important variable is your marginal tax bracket -- the rate paid on the last increment of income. The second variable is your willingness to invest after-tax cash in current investments paying above 8 1/2 percent.
One way to figure alternatives is to look at the taxable return you would need on the after-tax cash from your E-bonds. Options for investment are T-bills, money-market CDs, or money market mutual funds. Interest payable on the HH-bonds you get in exchange is taxed as ordinary income.
An example will show how it works: Supposed you are in a 32-percent marginal tax bracket. If you cashed in 10 $25 E-bonds at maturity and the total cash amounted to $730.10, you would owe $173.65 in taxes, leaving $556.48 to be invested.
Exchanging the matured E-bonds worth $730.10 for HH-bonds paying 8 1/2 percent would yield $62.14. You could not exchange $730.10 exactly, because HH-bonds are sold in denominations of $500, $1,000, $5,000, and $10,000. You could add extra cash to the exchange value of the mature E-bonds to make up any difference. For this example only the exchange value of $730.10 is considered.
For equivalent income of $556.48 after tax remainder would need to earn the same $62.14-a-year interest. The equivalent rate would be 11.2 percent. If you should be in a 50 percent tax bracket, the equivalent rate on after-tax dollars would grow to 13.6 percent. Following is a table of equivalent returns for various marginal tax brackets:
Marginal tax bracket Equivalent rate needed to match HH-bond interest 21% 10.1% 24% 10.4% 28% 10.8% 32% 11.2% 37% 11.7% 43% 12.5% 50% 13.6%
Two cautions should be considered:
* Although high interest rates are available on insured certificates and T-bills, these rates are volatile and may not continue. The 8 1/2 percent rate on HH-bonds is assured and is a direct obligation of the US government.
* Tax liabilities for interest on E-bonds exchanged for HH-bonds are only deferred -- not forgiven. Thus, someday you or your heirs will need to pay tax on accumulated E-bond intere st at ordinary income rates.