What’s GATT Got to Do With It?
Q: I understand that there are some changes planned in how interest will be paid on savings bonds. Unfortunately, I cannot find an authoritative source of information about this. Can you help?-- H.G .
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A: Buried within the legislation authorizing GATT--the General Agreement on Tariffs and Trade--was a provision giving the Treasury Department full authority over the setting of interest rates on U.S. savings bonds. Currently, federal legislation in effect since 1976 requires that bonds pay a rate of 4%. (Bonds held for more than five years can pay even more, depending on current market interest rates.) The new legislation removes the 4% guarantee and allows the Treasury Department to tie all rates to fluctuating market conditions.
It is important to emphasize that this program, which is expected to take up to three months to be fully developed and implemented, will affect only bonds sold after it goes into effect. Bonds sold between now and then and, of course, bonds currently held will not be affected.
The details of the new system have not been completely worked out. One plan under strong consideration would peg the interest rate paid during a bond’s first five years to 85% of the rate paid on the six-month Treasury note. (Bonds held for more than five years will continue to accrue interest as they currently do, at 85% of the average rate paid by Treasury notes with five years left to maturity.)
This change can be a big plus--or minus--for bond buyers, depending on prevailing interest rates. When market interest rates were low in the early 1990s, the guaranteed 4% paid by U.S. savings bonds was among the best deals in town--and the Treasury Department came to regret it as taxpayers used savings bonds as little more than a bank account or money-market fund, buying bonds one month and cashing them out a few months later when they needed the money. Under the possible changes, when market rates sink, so will the rates paid on savings bonds. However, when rates rise, savings bondholders will no longer be held to a 4% interest limit. That change would benefit bondholders in today’s interest rate environment because 85% of the most recently issued six-month T-bill works out to 5.15%.
Perhaps the biggest change under consideration is how all this interest will be accrued. Now it accrues monthly. But the Treasury Department is contemplating accruing it only semiannually. What does this mean? Nothing to bond buyers who hold the bonds to maturity. However, bondholders who sell before that would be wise to keep careful track of the dates of the yearly and half-yearly anniversaries of their bonds. Selling before those anniversaries would mean forfeiting up to nearly six-months’ interest.
Clearly the Treasury Department is counting on bondholders forfeiting some of that interest. According to a department spokesman, the government estimates that savings under the new interest payment plan could reach $120 million over a five-year period.
One big question still remains: why would a savings bond interest payment scheme be included in GATT? The answer tells us much about how the government operates. It seems that the Treasury Department has yearned for years to be rid of the 4% guarantee. It is also true that new legislation passed by Congress must be “deficit neutral.” To meet that requirement, the GATT bill needed to generate some revenue, and the Treasury Department’s desires offered a portion of the needed cash. Thus was born the link between GATT and savings bonds.
Sometimes It’s Better to Wait to Join 401(k)
Q: I was not eligible to join my company’s 401(k) plan this year. May I make a contribution to an individual retirement account? -- D.G .
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A: Even if you are an “active participant” in a qualified pension plan, such as a 401(k) plan, you may always have an IRA. The real issue is whether your IRA contributions will be tax-deductible.
Tax-deductible IRA contributions are available to taxpayers participating in another qualified pension plan, such as a 401(k), if they meet specific income limitations. For couples filing a joint tax return, the limit is an adjusted gross income of up to $50,000. For individuals, the upper income limit is $35,000.
In addition, tax-deductible IRA contributions are available to taxpayers ineligible or unwilling to join their company’s 401(k) plan during the tax year. There is one exception: If your employer makes contributions on your behalf to a 401(k) account, even if you make no contribution, you are deemed to be covered by the 401(k) account and thus not eligible for a tax-deductible IRA unless you meet the income limits.
In most cases, taxpayers who have a choice are better off enrolling in their company’s 401(k) plan rather than making a tax-deductible IRA contribution.
Why? Many employers match their employees’ 401(k) contributions--sometimes up to 50%--and thus increase an employee’s savings beyond the $2,000 an individual taxpayer is allowed as a deductible IRA contribution. Of course, if you are not eligible for enrollment in your company’s 401(k) plan until late in the year, it is likely that the $2,000 you are allowed to put into an IRA is greater than any 401(k) contributions you could make in that brief time. In this case, you would be wise to wait until the beginning of the new year to enroll in the 401(k) plan.
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Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.
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To help readers understand the complexities of 401(k) plans, The Times is offering a compilation of questions and answers from this column. To order, send a check for $5.91 to Times on Demand Publications, P.O. Box 60395, Los Angeles, CA 90060. Ask for Item No. 8519. Prices include tax and delivery fees.
