Savings Bonds vs. Muni Bonds as College Fund
Q: I have been buying U.S. Savings Bonds for the last three years for my child’s college fund. I have never fully understood what happens after the bonds mature. If I keep the bonds for 16 years, until they are needed to pay for college, what will their value be? What about municipal bonds? Can I buy these through payroll deductions, as well? Which option would I have more luck with? --P. C.
A: Series EE Savings Bonds mature 12 years after being issued and, at that time, are worth--at the very minimum--the value printed on them.
Why the uncertainty about their value? Because for the first five years after they are issued, the bonds pay an interest rate that is fixed at the time they are sold. After the first five years, however, the interest rate varies every six months--according to the prevailing cost of money.
If interest rates are rising, the U.S. government will adjust the rate upward; if rates are falling, so will that paid on the bonds. So, although you can never be sure exactly what the bonds will be worth when you redeem them, if you hold them until maturity, they will not be worth any less than their face value.
Zero-coupon municipal bonds, which pay interest only at maturity, are entirely different. You are perhaps confused because in a recent Money Talk column, I compared the state of California’s October sale of “college saver” state bonds to municipal bonds. The column noted that the state’s bond issue, while in far smaller denominations to appeal to the small saver, was otherwise virtually identical to a zero-coupon municipal bond issue.
Municipal bonds and state college saver bonds--if they are ever issued again--are available only through selected brokers and financial institutions. There are no payroll deduction plans for such purchases.
Will you have more luck with EE Savings Bonds or municipal bonds? No one can say for sure. Each has pluses and minuses that you should consider carefully before making a decision.
For convenience and safety, you can’t do better than U.S. Savings Bonds. However, if you want to maximize your investment and don’t mind taking a little more risk and spending extra time and effort doing research, municipal bonds can be a good investment, especially if you hold them until maturity and select your investment carefully.
California municipal bonds are double-tax-free: You pay neither state nor federal income tax on the interest they generate. Traditional U.S. Savings Bonds are still subject to federal tax. Although the U.S. government’s new Series EE college savings bonds are tax-free, the tax exemption is gradually phased out for families with an annual adjusted gross income of $60,000 and up.
Another point to consider is how you can use the bond proceeds when they mature. There are no restrictions with municipal bonds or college saver state bonds. However, proceeds from Series EE college savings bonds may be used only for college expenses.
By the way, zero-coupon municipal bonds or state bonds are best suited to portfolios of only those in the highest tax bracket--since one of their major advantages is their tax-exempt status. Finally, don’t buy them if you think you might have to sell them prematurely. The value of zero-coupon bonds can fluctuate wildly in the secondary market due to interest rate changes, so buyers should plan on holding them to maturity.
Parted Couple Can Share Home Tax Break
Q: My husband moved out of our house in 1987. There is no legal separation or divorce; he just lives elsewhere. What happens with the $125,000 profit exemption when the house is sold? --M.T.B.
A: Assuming that at least one of you is over 55 and has lived in the house for three of the past five years--and there is no divorce or legal separation decree--our experts say you and your husband are entitled to share a single $125,000 exemption.
If you were to divorce or file for a decree of separate maintenance, you could possibly qualify for two exemptions. However, the IRS could balk at your husband’s qualifying for an exemption because he has not lived in the house for three of the past five years.
Wife’s Earnings Won’t Halt His Social Security
Q: I plan to start receiving Social Security upon turning 62 in three years. My wife, who is four years younger than I, would continue working for a few more years after I retire. Will her income affect my benefits, especially the earning limits of $6,840 for Social Security recipients? --F.E.C.
A: Not at all. The income limits you mention apply only to the earnings of the Social Security recipient--or any beneficiary also receiving payments on the primary recipient’s account. Since you will be receiving payments from your own account, what your wife earns will not in any way affect the level of Social Security payments you are entitled to receive. Now, if you were to begin receiving spousal benefits from your wife’s account before she stops working, then your benefits would be reduced, since the primary recipient is still a wage earner.
By the way, you should know that although your Social Security benefits will not be reduced because your wife continues to work, they could be subject to taxation if your yearly household income--including Social Security as well as unearned investment income--exceeds $32,000 per year per couple or $25,000 for an individual. Once you cross this threshold, you will be required to pay income tax on half your Social Security benefits.
Congress imposed this requirement as a way of recouping taxes on the one-half of your Social Security benefits that was contributed by your employer and never taxed. The tax applies only to those with household income in excess of $32,000 (couples) and $25,000 (individuals) in order not to hurt the less wealthy.
