As Interest Rates Fall, Savings Bonds Look Better

Boring, old-fashioned Series EE savings bonds look better and better as interest rates get lower and lower.

These small savings instruments used to pay such a low rate of interest that they were not deemed worthwhile. Several years ago, the Treasury gave them adjustable rates so they would be more competitive.

In times like these, when market rates are falling fast, the six-month schedule by which the Treasury adjusts savings bonds rates works in investors’ favor. Rates on bank certificates and Treasury bills auctioned every month are plummeting, but the rate on Series EE bonds won’t be adjusted again until April 1, 1992.

A series EE bond, bought now at half its face value and held to its 12-year maturity, will pay 6.38% annually. Hold it for five years, and it offers a guaranteed return of 6% per year.

These are a viable option for people who have funds tied up in bank certificates that are rolling over at rates below 6%. And the special tax breaks offered by government savings bonds makes them even more attractive in certain situations.

Interest on these bonds is exempt from state and local income taxes and is deferred from federal income taxation until the bond is cashed and the interest received. That makes them worth more to people in middle and top tax brackets and for children who are under 14 but will be over 14 after the bond is paid off.

That’s because children under 14 are taxed at their parent’s tax rate; over 14, they are charged at their own rate.

A youngster could accumulate college savings in Series EE bonds and not cash them until tuition time. The earnings would be subject to the student’s presumably lower income tax rate instead of his or her parents’ rate.

Some parents can using savings bonds as a tax free-college savings instrument. Interest earned on savings bonds held in parents’ names--but sold to pay for college costs--is tax exempt above certain income levels.

For 1991, that income is completely tax exempt for single parents with income below $41,950 and married parents filing jointly with income below $62,900. The tax exemption is phased out gradually up to incomes of $57,700 for single parents and $94,350 for married parents. The income figures are adjusted upward every year for inflation by the Internal Revenue Service.

Consider this: Parents in the 28% tax bracket who buy savings bonds at 6.38%, and sell them to pay for their children’s college education under the tax-free program, will have earned the equivalent of 8.86% in taxable interest over those years.

Unfortunately, Series EE bonds don’t provide much of an answer for income-dependent investors who need to receive regular interest checks for living expenses. Series EE bonds don’t pay interest until they are cashed in; the interest is then paid in a lump sum.

Series HH bonds--which can be obtained only by cashing in Series EE bonds--pay interest in semiannual installments. Someone who already has Series EE bonds that have matured can trade them in for HH bonds in denominations starting at $500 and receive the same state and local tax exemption and federal tax deferral and the same 6% floor on interest.

Series EE bonds can be bought in denominations as small as $50 and as large as $10,000, without commission, from a bank or savings and loan. A Treasury Department information line, (202) 447-1775, gives rates and other information about the savings bond program.