Savings bond rates vary after May 1

March 25, 1995|By Newsday

Savings bonds are in for a change and it doesn't look good for consumers, financial experts say.

Long a favorite with small investors and families saving for college, reliable old savings bonds will switch to a variable interest-rate system starting May 1. Bonds issued before that date will not be affected by the changes.

Gone is the system in which a floor was placed under the interest rate, recently 4 percent. Gone, too, is a formula for the first five years that was pegged to the higher-yielding five-year Treasury note.

Under the new program, the interest rate on savings bonds will adjust every six months. During the first five years, the rate will be 85 percent of the average yield on lower-paying six-month Treasury bills. After that, the rate will be 85 percent of the average yield on five-year Treasury notes, much like the current formula.

The Treasury Department said the change will make savings bonds simpler and easier to understand. "This is the latest in a series of changes Treasury has made over the years to keep savings bonds the safest and most convenient way for Americans to save," said Treasury Secretary Robert E. Rubin.

But some people disagree.

"Savings bonds are one of the most complicated gizmos anyone could come up with," said Bob Heady, publisher of Bank Rate Monitor, a North Palm Beach, Fla., newsletter that follows interest rates on savings. "You need a degree from Wharton and a Buck Rogers calculator to figure them out."

And if you do figure them out, say the experts, you may be disappointed.

If the rate on the new savings bond is linked to short-term Treasuries for the first five years, consumers will be shortchanged, some financial planners said, since short-term Treasuries pay less than five-year notes.

Why, asks Jonathan Pond, author of the New Century Family Money Book, would you accept a short-term rate on a long-term investment?

Madeline Noveck, a New York financial planner, added that under the new system, you can lose nearly six months of interest if you cash in a savings bond at the wrong time. The interest will be added to the value of the bond only at the end of six-month intervals, so any bonds redeemed between those key dates will get only the interest already credited.

There no longer will be a floor on rates. However, if investors hold a savings bond for 17 years, they will be assured of receiving slightly more than 4 percent on their investment. According to the Treasury Department, however, the bonds are held, on average, for about 10 years.

"This is bad for the small saver," Mr. Noveck says. "There is hardly any reason to use a savings bond. The only advantage that survives is the tax deferral." Investors don't owe income taxes on savings bonds until they cash them in, and there are no state or city income taxes.

Of course, if you happen to invest in a savings bond at a time when interest rates suddenly spike up, your investment will ride along with the upward trend.

"But it's a bad deal if rates plunge as they did between 1989 and 1994," Mr. Heady says. "The bottom line is, the Treasury Department has shifted the interest rate risk onto the shoulders of consumers."

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