43-Year Old U.S. Bonds No Longer Pay Interest

QUESTION: I recently discovered some Series E savings bonds that my parents bought for me in 1945. They have a face value of $100. What are they worth now? What should I do with them?--Q. M.

ANSWER: Depending on the month in 1945 that they were issued, your $100 savings bonds are worth between $441.88 and $468.12 each. And, according to Stephen Meyerhardt, a spokesman for the Savings Bond division of the Treasury Department, you should immediately redeem them because they stopped earning interest in 1985, when they reached their 40-year maturity. The bonds are redeemable at most banks and savings and loans. In Los Angeles, you can even take them directly to the Federal Reserve Bank at 950 S. Grand Ave.

However, there is something you should know before you start counting your riches: You are liable for taxes on the interest you receive when you cash in the bonds. Your total interest on the bonds will be their current value minus their cost, in your case the $75 that your parents paid for them.

Savings bond holders who want to defer their tax obligations can convert their expired bonds to new issues, but only within one year after they stop accruing interest. Furthermore, bondholders wishing to reinvest their proceeds are limited to purchasing Series HH bonds, which are available only in lots of $500 or more. Series HH bonds pay interest semiannually; the current rate is 6%.

Q: Lately, there have been many days on the New York Stock Exchange where by far the most active stock was a “dividend play.” For example, on May 18, 64 million shares of Philadelphia Electric (or one-third of the company’s total outstanding shares) were traded because the following day was the ex-dividend day, the date on which owners of record no longer qualify to collect the current quarterly dividend. However, throughout the trading day, there was very little change in the price of the shares, although there was the customary drop on the following day, when the stock went ex-dividend.

Please explain how such a big proportion of the company shares could be traded with practically no change in price. Also, how can there be an advantage in buying stock just before the ex-dividend day, since the price of the shares usually drops the next day by the very amount of the dividend?--D. Y.

A: You have raised an interesting and provocative issue, and one that no doubt has puzzled many smaller stock market investors. According to John D. Connolly, chief investment strategist at Dean Witter in New York, there is a definite investment and tax strategy to the huge dividend-related trades you have observed. And, according to Connolly, here’s what it is:

Because the tax laws allow corporations to exclude 80% of their dividend income from taxation, the effective tax rate for this revenue is 6.8%, far lower than the maximum 34% tax rate that corporate profits and interest income are subject to. At the same time, these corporations don’t necessarily object to paying a premium for capturing the extra dividend payment because as the purchase price rises, the corporation’s potential capital gains--which are taxed at the maximum 34% rate--drops. “There’s an economic incentive to capture dividend income,” Connolly says. Indeed: 6.8% taxation if the income is generated by dividend payments, compared to a maximum of 34% on profits or capital gains.

Connolly says dividend-capture trading, as the practice is called, doesn’t really affect the price of the stock, just who gets--and pays a premium for--the dividend. Hence, large blocks of stock will change hands without any great fluctuation in the price of the shares.

Commissions for these large transactions are low. They typically run about a penny a share, far below the usual 6 or 7 cents a share charged to institutional traders.

By the way, dividend-related trading is gaining popularity, particularly among Japanese corporations, which have been known to go to great lengths to capture dividend income. Japanese life insurers are among the most active players of the dividend game because they are obligated to pay 7% to 8% annual yields to policyholders. However, Japanese regulations require that these payments must come from dividend income, not capital gains. Although the life insurers have sufficient capital gains income from their Japanese investments, their dividend income is meager. Hence the interest in American utilities and other high-yielding stocks.