U.S. spruces up Series EE bonds Interest now accrues monthly, keyed to 5-year securities

But an early-draw penalty

Investing

January 02, 1998|By William Patalon III | William Patalon III,SUN STAFF

Savings bonds will never generate the big returns that are possible with stocks. But thanks to some new rules enacted last year, savings bonds may be a bit more alluring to super-conservative investors who want to shield some of their money from the gyrations that stocks sometimes experience.

With the changes, the government is "trying to pump some excitement" back into savings bonds, said Daniel J. Pederson, head of Savings Bond Informer Inc., a Detroit-based investment advisory firm.

"The changes are good as far as they go," said Pederson, who has published a book, "U.S. Savings Bonds: A Comprehensive Guide for Bond Owners and Financial Professionals."

The key changes, which affect Series EE savings bonds sold on or after May 1, 1997:

The bonds earn interest right from the start, based on the average yields of 5-year Treasury securities -- instead of on the six-month Treasuries for the first five years of their life, as was the case previously.

Interest on the bonds accrues monthly, instead of twice annually, meaning the bonds increase in value each month. Interest compounds semiannually.

Bondholders who redeem the EE bonds before they've been held for five years will pay a three-month interest penalty.

These changes make savings bonds simpler to understand, said Sheila Nelson, spokeswoman for the Bureau of the Public Debt, which administers the savings bond program.

"We wanted them to be easier to own; we want people to buy them," Nelson said.

Up to now, savings bonds haven't always been easy to own. Indeed, for an investment that's so widely held, they were actually very complex debt securities, with multitiered interest rates and hidden penalties for savers who cashed the bonds in at the wrong time.

About 55 million people own bonds and those bonds right now could be cashed in for $185 billion, Pederson says. What's more, there are an estimated $4 billion in bonds being held that are no longer accruing interest.

However, many investors have soured on savings bonds as investments because of a surging stock market and interest rates on the EE bonds that pale in comparison, says Glen Buco, a vice president for West Financial Services in Annandale, Va.

"You hardly see them anymore," he said. "A few clients hold them here and there, but I've not done anything much with savings bonds for a long time."

Savings bonds, born in the early 1940s as war bonds, once were a ubiquitous American investment. And in the 1980s, they were a red-hot investment -- fueled by their guaranteed payout of 7.5 percent for 10 years. The government reduced that guarantee to 4 percent in March 1993 and eliminated it altogether in favor of a variable rate in May 1995.

Bond sales have dropped precipitously since peaking at $17.7 billion in 1992, Pederson said.

Bonds are free of state and local taxes and all federal taxes on the interest are deferred until they are cashed in. They are sold in denominations ranging from $50 to $10,000.

Starting May 1, 1997, the bonds paid holders an interest rate equal to 90 percent of the average yields on 5-year Treasury securities for the previous six months. The rates, reset every six months, were 5.68 percent as of May 1 and 5.59 percent as of Nov. 1.

The new method for setting the rates means the bonds have yields that are 1 to 1.5 percentage points higher than bonds sold under the previous, two-tiered method, Pederson said. Particularly for a conservative investor, that's a big difference, he said.

The monthly accrual of interest also works to investors' BTC advantage. Before, when the bonds increased in value just every six months, an investor could cash in a bond in the fifth month and leave five months' interest on the table. That can't happen with the new bonds, Pederson said.

However, Pederson isn't wild about the three-month interest penalty paid by investors who hold the bonds for less than five years.

"That's the first time they've invoked [an explicit] penalty," he said.

Pub Date: 1/02/98

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