Soon-to-die HH savings bond can still save you money after its demise Your Money

PERSONAL FINANCE

August 01, 2004|By EILEEN AMBROSE

TIME IS RUNNING out for HH savings bonds and investors who may want them.

At the end of this month, the federal government will stop issuing new HH bonds, which were introduced 24 years ago.

The HH bond was never as popular as its siblings - Series EE and I bonds - which was part of the problem. Investors have more than $205 billion tied up in all types of savings bonds, but only $14.2 billion of that, or about 7 percent, is held in HH bonds.

With low demand for HH bonds, the Treasury Department concluded they weren't worth the administrative expense.

As word of HH bonds' retirement gets out, though, there has been an uptick of interest in them by investors, said Stephen Meyerhardt, a spokesman with the Treasury's Bureau of Public Debt. "I would suspect there will be more of a rush in August, when people figure out it's now or never."

HH bonds aren't like other savings bonds.

For example, HH bonds provide an income stream by paying out interest every six months, which many retirees like, experts said. Investors pay only federal income taxes on the interest earned each year.

With Series EE and I bonds, on the other hand, interest accrues and is paid out when investors cash in the bonds. Investors owe federal tax on the interest when the bonds mature or are redeemed.

Also, investors don't buy HH bonds with cash as they do other bonds. Instead, they exchange Series E or EE bonds for HH bonds, which have a minimum denomination of $500.

The big advantage to this exchange is that investors can postpone a potentially huge tax bill. Interest built up over the years in E or EE bonds won't be taxed while the money sits in HH bonds. Once HH bonds are cashed or mature, the tax bill comes due. But with a 30-year maturity for EE bonds and 20 years for HH bonds, an investor can defer taxes on the interest earned on an EE bond for up to 50 years.

"The nice thing about the HH bonds is you could extend your Series E bonds without a taxable event and get current interest," said Barbara Pietrowski, a certified public accountant and financial planner in Kensington. "It was a real benefit to many small investors."

Not everyone, though, will miss HH bonds.

"The best thing about government bonds is that they are safe. The worst thing is a very poor return," said Dennis Hebert, a financial planner in Syracuse, N.Y.

The interest rate on HH bonds was cut last year from 4 percent. HH bonds issued January 2003 and later pay a rate of 1.5 percent for 10 years, at which time the rate can be reset for the remaining life of the bonds.

If you already own HH bonds, don't worry. You can continue holding them until they mature.

But investors who are weighing the pros and cons of acquiring HH bonds have until Aug. 31 to make up their minds. Whether HH bonds make sense for them will depend on a variety of factors, including their tax bracket now and in the future or how much investment risk they can handle, Pietrowski said.

Reasons not to convert to HH bonds:

If you have years to go before E or EE bonds mature, you might as well keep earning interest at a higher rate than an HH bond offers, said William E. Massey, a senior tax analyst with RIA, a New York company that provides tax information and software to tax professionals.

New EE bonds pay an interest rate of 2.84 percent, while older EE bonds can pay as much as 6 percent. "If you have a long way to go on bonds paying 6 percent interest, certainly you don't want to exchange them for 1.5 percent, even for the [tax] deferral," Massey said.

Also, if you have little interest accrued in maturing E or EE bonds, there's no reason to switch because the tax hit won't be much, either, Massey said.

Or, investors might be better off cashing in maturing E and EE bonds, paying the tax, and investing the remainder elsewhere, such as in dividend-paying stocks, for a higher return, Massey said.

This has become a more attractive move, too, given last year's tax cuts on dividend income and long-term capital gains. Dividends and gains are now taxed at rates of 15 percent and 5 percent, depending on income.

The case to switch to HH bonds:

The amount of interest accrued on E and EE bonds over many years can add up to tens of thousands of dollars. If those bonds have recently matured or are maturing soon, an investor will be faced with having to pay income taxes on all that interest in a single year unless they convert to HH bonds.

There can be other problems, too. If the interest earned is sizable enough, it could push a taxpayer into a higher tax bracket or trigger other negative tax consequences, Massey said.

Retirees, for example, might find as much as 85 percent of their Social Security benefits are subject to tax because their income went up, he said. They may no longer qualify for the lowest tax rate on dividends and capital gains.

Or, because their income is higher, they could lose some or all of their medical deductions, Massey said. Taxpayers can deduct medical expenses that exceed 7.5 percent of adjusted gross income. As income rises, so does the threshold for medical deductions.

By switching to HH bonds now, investors can gradually redeem the bonds over time to better control their tax bite, Massey said.

Taxes aren't the only reason why investors might want HH bonds. For some risk-averse investors, the security offered by savings bonds backed by the U.S. government is more important than the lure of higher returns, Pietrowski said.

"People who buy Series EE and Series HH bonds are very conservative people," she said. "They are comfortable with these investments even though the return right now is pretty low."

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com.

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