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Mix of good, bad news for savings bond owners

By HELEN HUNTLEY
Published April 10, 2005

The makeover U.S. savings bonds are getting in May is both good and bad news for savers.

The good news: Savings bond owners at last will know how much their bonds are earning. The bad news: They won't be earning very much.

Savings bonds are a longtime favorite of small investors. Many workplace savers have accumulated stacks of them through payroll deduction and they're beloved by grandparents who would rather give a bond than cash that will be spent on a video game. Because EE bonds are sold for half their face value, they make impressive birthday or holiday gifts - you can give a $50 bond for just $25.

But under current rules, savings bonds are complicated investments. The rate they earn changes every six months based on current interest rates and when the bonds were purchased. Different rules apply depending on whether a bond is in its "original maturity" period (anywhere from eight to 20 years) or whether it has moved into "extended maturity."

The planned makeover will simplify things considerably. New rates will continue to be announced every six months, but starting May 1, the interest rate in effect at purchase will apply for the life of a new EE bond - or at least the first 20 years. The government reserves the right to change the bond's interest rate for the final 10 years.

The bonds will come with the guarantee that they'll double in value over 20 years, the equivalent of earning about 3.5 percent annual interest. If they fall short, the Treasury will bump up the bond's value at the end of 20 years. As is the case now, you'll lose three months' interest if you don't hold a bond at least five years.

But there's a big problem with locking up a rate for decades. Interest rates are rising and the new bonds won't give you an opportunity to take advantage of them. You can cash in a bond, but if you do, you'll have to pay the deferred taxes.

There's no doubt that the changes should make EE savings bonds easier to understand, but if you're looking for a decent return on your money, EE bonds purchased at low fixed rates will be less likely to provide it.

When the reward is there, complications can be worth enduring. I bonds, which will continue to adjust with both market rates and the rate of inflation, look like they'll become a much more attractive alternative. The Treasury's current rates are 3.25 percent for EE bonds and 3.67 percent for I bonds, both of which are likely to increase May 1.

I am currently employed and am considering buying a business. How do I get cash out of my 401(k) and 457 retirement savings plans to help finance my new business without creating a taxable event?

You can borrow the money rather than withdrawing it, assuming that your plans allow loans. However, the rules that regulate retirement plan loans may not permit you to accomplish what you have in mind.

IRS rules allow borrowing a maximum of half the value of your account, up to $50,000, without triggering a tax liability. The amount is reduced if you have had a loan outstanding during the previous year. You must make regular payments and the loan must be repaid within five years unless it is being used to buy a house. You may be required to repay the loan in full if you leave the company. If you cannot, the balance will be considered a taxable distribution. Your plan may have additional rules. The way to find out the rules that affect you is to contact your plans' administrators.

The worst part about borrowing from a retirement plan is that you are putting your retirement security at risk. Carefully research the business you are considering and make sure your expectations of return are realistic before you take the plunge.

NOTE TO READERS: The President's Advisory Panel on Federal Tax Reform is soliciting your ideas for the kind of tax system the United States should have. Details regarding the request are available on the panel Web site (www.taxreformpanel.gov) Typewritten statements of up to five pages double spaced may be mailed to the panel at 1440 New York Ave. NW, Suite 2100, Washington, DC 20220.

Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to huntley@sptimes.com or Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.

[Last modified September 2, 2005, 16:01:35]