Keeping stock of savings bonds yields benefits

Keeping stock of savings bonds yields benefits
By Andrew Leckey
a Tribune Media Services columnist
Copyright © 2006, Chicago Tribune
Posted October 1, 2006



Love 'em and leave 'em.

That's the attitude of American investors holding $14.5 billion worth of U.S. savings bonds that have stopped accruing interest because the bonds are more than 30 years old.

Those who purchased Series EE bonds now wouldn't touch them with a 10-foot pole. Stagnant savings bonds symbolize one of several mistakes that experts say investors commonly make with this instrument.

Backed by a new nation's full faith and credit, savings bonds were introduced in 1776 to finance the American Revolution. Uncle Sam has hawked them since the War of 1812. The first Series E U.S. savings bond was sold to President Franklin D. Roosevelt in 1941, and the instrument contributed significantly to the World War II effort.

Unfortunately, a national tradition can spawn a tradition of mistakes.

Mistake No. 1: Owners allow expired savings bonds to collect dust because they don't want to incur the tax liability involved in cashing them in.

"I call these `stinker' savings bonds because if they're not earning interest, they are a terrible investment," said Tom Adams, who runs Savings-bond-advisor.com. "Even though people say they can't afford to pay the taxes, the reality is they just need to put some of the money aside to pay those taxes when they cash them in."

Investors assume that by delaying the decision they'll never have to pay tax because the savings bonds will outlive them. But their heirs will be stuck with the tax bill because deferred tax on savings bonds never dies.

"Our record-keeping office that seeks the owners of these securities tells them that in the long run it would be better to be earning interest on their money," said Stephen Meyerhardt, spokesman for the U.S. Treasury's Bureau of Public Debt. "But whether the amount is substantial or not, they've been told for 30-plus years that paying any tax at all is a very bad thing and they just don't intend to do it."

Mistake No. 2: Investors forget about their savings bonds for many years and then suddenly wake up to wonder what they may be worth.

"A lot of clients come in with big stacks of U.S. Savings Bonds and ask us to run an analysis on them all to make sure they're still earning interest," said Marilyn Capelli Dimitroff, a certified financial planner and president of Capelli Financial Services Inc. in Bloomfield Hills, Mich. "They'd forgotten about them altogether for years."

Mistake No. 3: Some investors cash in every savings bond they own all at once in the same tax year. This generally occurs just before retirement when they're in the highest tax bracket of their working lives.

As a result, they're socked with massive additional income from all that built-up interest when they should instead be patient and take their time.

"This is the deferred-tax `time bomb' because people who buy their savings bonds over an extended period of time should also cash them in the same way," Adams said. "That's the way to even out the income flow and avoid having a large lump of income in one year."

Mistake No. 4: Many investors don't understand that inflation-adjusted savings bonds, known as I-bonds, can fluctuate significantly and aren't fully aware that Series EE bonds also are considerably different these days.

Although the I-bond's fixed base rate never changes over its life, it earns additional interest based on the current inflation rate that is calculated every six months. That can make a big difference, especially in periods of inflation peaks and valleys, such as those that took place over the past year.

Investment in I-bonds hit a 10-year high early this year, when the rate was 6.73 percent but then fell to a 20-year low when its rate declined significantly in May to the current 2.41 percent.

"Investors should never make the mistake of getting into I-bonds when rates are high and pulling out when rates are low," said Adams, who expects the I-bond rate to increase to more than 5 percent Nov. 1 and revitalize that market again.

Finally, in May 2005, the U.S. Treasury started selling the Series EE savings bond at a fixed rate instead of the variable rate previously offered. This rate--currently at 3.7 percent--is now good for 20 years, with the Treasury able to set a new rate for the last 10 years of the bond's 30-year life.

"For certain investors, especially those starting out, savings bonds can make sense because they're free of state taxes, you can defer the federal tax and you can use them to fund college expenses if you meet certain income criteria," Capelli Dimitroff said.

"They're not marketable, because you can't sell them to anybody else, but the only other risk is having to give up three months of interest income when you cash in early."

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Andrew Leckey is a Tribune Media Services columnist.