Tax Benefits of U.S. Savings Bonds
QUESTION: You wrote last week about Treasury bills being a good investment because the income from them isn’t taxable at the state and local level. Since Series EE savings bonds are issued by the federal government, too, do they have the same advantage? I had always thought they escaped federal taxes but were taxed by the state.--C. E. E.
ANSWER: Purely from a tax point of view, Series EE savings bonds actually have more advantages than Treasury bills. Yes, they, like Treasury bills, are exempt from state and local taxes. But there’s more. You get to choose when to pay federal income taxes on the income from these bonds--either as the interest accumulates or, if you prefer, not until the bonds are redeemed.
Why, if you can defer federal taxes for 10 years or more, would you want instead to choose to declare the income annually? (Savings bonds have a stated maturity of 10 years, but the government often extends the maturity date as the bonds approach the end of their original maturity period. Series E bonds purchased in the 1940s, for example, had a final maturity of 40 years.)
Say you are buying bonds for your children. By having them declare the income, it would be taxed at their tax rate instead of yours, which is bound to be much higher. Since most children have little or no income, there is likely to be no tax whatsoever on the income.
Another tax benefit of this type of U.S. savings bond is that the owner’s death does not trigger the bond’s redemption and immediate taxation. When the owner dies, the bond can be passed on to a beneficiary. No tax is due until the bond matures.
For those readers who are confused by the designation Series EE, there are two types of U.S. savings bonds. The Series EE bond is the savings bond most people are familiar with. You buy it for half of its face value--that is, the amount you receive when the bond matures and you cash it in--and watch while the value builds over 10 years. Thus, a $100 bond costs $50. You receive no income in the interim. These bonds are available in denominations of $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000.
The other type of savings bond is the Series HH. You buy these either by accumulating at least $500 worth of Series EE bonds, savings notes or the old Series E bonds and trading them in or with the proceeds of old Series H bonds that have matured. These bonds are purchased for their face value and redeemed for the same amount. Every six months in between, you receive a check from the U.S. Treasury Department representing the interest that has accumulated on the bond. These bonds are available in denominations of $500, $1,000, $5,000 and $10,000.
The tax advantage of owning Series EE bonds continues, by the way, even when you trade them in for Series HH savings bonds. As long as you exchange them no later than one year after the Series EE bonds reach final maturity, you may continue to postpone taxation of the interest that built up while the bond was a Series EE type. Not until the new HH bond is cashed in do you have to report the Series EE income to the government for tax purposes. You do, however, have to report yearly--and pay taxes on--the semiannual interest earned by the HH bonds.
The interest and principal of both types of bonds are guaranteed by the U.S. government. And if they are lost, damaged or stolen, they will be replaced, without charge. Both types are eligible for redemption six months after they are issued.
Savings bonds are not the low-return investments they once were. In November, 1982, Congress gave the Treasury Department permission to index the interest on new EE bonds to a rate equal to 85% of that paid on five-year Treasury bonds. More important still, Treasury set a minimum rate for bonds that are held at least five years--7.5%. The rate, adjusted every May 1 and Nov. 1, is now 8.36%. That is down from the 9.49% that they were paying last year, but it is still higher than rates on one-year certificates of deposit and Treasury securities.
Series HH bonds issued on or after Nov. 1, 1982, pay interest at a rate of 7.5%.
Series EE bonds are available at banks, savings and loan associations and other financial institutions. Many employers also offer them for purchase by their employees through payroll deduction plans. Series HH bonds are available at Federal Reserve banks and branches and from the Bureau of the Public Debt in Washington. Many financial institutions that issue Series EE bonds will forward your bond exchange application to these federal agencies.
Financial institutions are not permitted to charge a fee for issuing or redeeming bonds. The Treasury Department reimburses them for the time and money involved in handling these investments. All you need when it comes time to redeem a Series EE (or old Series E) bond is some form of identification.
Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Business Section, The Times, Times Mirror Square, Los Angeles 90053.
