Q & A : New Rate May Change Savings Bonds’ Appeal

The U.S. Treasury’s decision Saturday to lower guaranteed interest rates on savings bonds has rattled many investors, who say they are alternately confused or disenchanted by the change.

“I’m going to stop buying bonds,” said Daniel J. Johanon, a Detroit electrician who is saving for his children’s education. “I need to put my money in something that earns more than 4%.”

Of course, not everyone has decided to abandon savings bonds. Indeed, some older savers say they continue to find the tax-deferred earnings and safety of savings bonds compelling.

However, Treasury officials, who note that savings bond sales had been booming thanks to their relatively high yield, say the decision to lower so-called guaranteed rates to 4% from 6% has prompted a flood of phone calls from current and potential investors who have questions about what the rate change means, who it affects and whether these bonds still make sense.

Here are the answers to some commonly asked questions.

Q. What did the U.S. Department of Treasury do?

A. It lowered the guaranteed rate, which is the lowest rate you can get on long-term savings bond holdings.

Short-term savings bond rates are adjusted every six months based on going rates for other Treasury securities.

But investors who hold their bonds for at least five years get a guarantee that their rate will never fall below a certain level.

Until Monday, the guaranteed rate was 6%, which is about 1% higher than the current market rate of 5.04%.

The new guaranteed rate of 4% applies to bonds purchased starting March 1.

Q. Does that mean I’m earning less on savings bonds that I already own?

A. No. Bonds purchased between November, 1986, and February, 1993, get the 6% guarantee locked in for the first 12 years, assuming they’re held for the minimum five-year period.

Q. What about bonds purchased before 1986?

A. Your current rate--which is probably 7.5%--is locked in until the bonds hit their next extension period. At that point, the guaranteed rate would drop to 4%.

Q. How do I know what interest rate I’m earning on my savings bonds?

A. You can find out the current rate by calling (800) 4US-BOND. However, if you’ve held your bonds for several years, the rate you’ve earned over that time is a blended rate that takes into account several rate changes.

Q. Does the lower guaranteed rate mean that savings bonds aren’t a good investment anymore?

A. Not necessarily. If you’re in a high tax bracket and you don’t like investment risk, you may still find that savings bonds are worth a look. That’s because they pay more than the guaranteed rate when market interest rates are higher. And investment earnings accrue free of federal taxes until the bonds are redeemed. Savings bond earnings also are always exempt from state and local tax, which in high-tax states such as California and New York is a significant advantage.

Q. How does the tax break affect my after-tax return?

A. It depends on where you live and how you handle your savings bonds. But let’s assume you’re a well-heeled Californian, where the top state income tax rate is 11%, and you continue to roll the gain from your bonds into more tax-deferred savings bonds. At today’s tax rates, the 4% savings bond rate is equivalent to a 6.37% taxable yield, says Gregg Ritchie, partner at KPMG Peat Marwick in Los Angeles. However, if President Clinton succeeds in raising tax rates on the wealthy, you’d have to earn 7.43% on a taxable investment to get a yield equivalent to the 4% rate, Ritchie adds.

Q. How does that compare to yields on comparable investments?

A. It’s more than what you’d earn on most savings accounts. And it’s a little less than you’d earn on longer-term Treasuries. However, savings bonds have some advantages over either of these investments. Specifically, you usually have to pay annual or monthly account fees on savings accounts. And Treasuries that are sold early must be sold through a broker at current market prices, which subject you to certain fees and risks that are not necessary with savings bonds.

Q. What are the disadvantages of savings bonds?

A. They’re a do-it-yourself investment and it’s hard to get pertinent information in a hurry. Additionally, only one of the two types of savings bonds, the Series EE, can be purchased for cash. (You can only get the other type, Series HH, by trading in your Series EE bonds.) And the Series EE bond doesn’t pay current interest. It’s essentially a zero coupon bond that you buy at a discount. A $50 bond would be purchased for $25 today and mature at face value in 18 years. If you hold it past the maturity date, it will be worth more. When you want to get your interest earnings out, you have to sell.

Finally, there are quirks that can affect your return. For example, interest accrues on older bonds every six months. If you sell a day before the interest is paid, you lose out on six months’ worth of earnings. But no one is going to tell you not to sell that day--you have to figure it out yourself.

Q. How do I know when my interest accrues?

A. It’s usually on the anniversary dates of your purchase. Bonds purchased in January normally accrue interest in January and July, for example. But some bonds have less logical interest accrual dates. A January, 1970, bond pays interest in May and November, for example. Newly purchased bonds accrue interest monthly. To find out interest accrual dates on old bonds, ask the Treasury for a table of interest accrual dates.

Q. Will the yield on savings bonds ever drop to less than market rates?

A. Yes. After the “final” maturity date, the bonds stop accruing interest. Final maturity is usually 30 to 40 years after the purchase date.

Q. I’ve got more than two dozen bonds that were purchased at different times through payroll savings. How do I determine what each bond is worth and when or whether I should sell?

A. You’ve got two choices. You can get redemption tables and interest accrual dates from the Treasury and figure it out on your own, or you can pay somebody else to do it. An organization called the Savings Bond Informer in Detroit does detailed reports on savings bonds for a relatively modest fee. It costs $14.50 for a report on up to 25 bonds. The fees ratchet up a bit from there. The report gives the average interest rate earned on each bond, months that the bonds increase in value and what they’re worth today. You can get a sample report from the Savings Bond Informer by calling (800) 927-1901.

Q. How do I get information from the Treasury?

A. Write to the Savings Bond Division, U.S. Department of the Treasury, 800 K St. N.W., Washington, D.C. 20226. If you’re trying to figure what your bonds are worth and when interest is paid, ask for a PD-3600, which is an abbreviated redemption table, and a table of interest accrual dates.

The Treasury also puts out a brochure called “The Savings Bond Question and Answer Book,” which explains a variety of issues, including how to register, redeem and exchange the bonds.

Savings Bond Boom

Thanks to their relatively attractive yields, sales of U.S. savings bonds soared to record highs in 1992. But the Treasury Department’s lowering of the guaranteed annual rate to 4% from 6% could hurt sales.

Year sales (billions of dollars) 1992 $17.66 1991 $9.49 1990 $8.04 1989 $7.64 1988 $7.41

Source: Savings Bond Division, Treasury Department