Better rates help US savings bonds shed stodgy image

So, what's a good place to put my money when interest rates are down? How about United States savings bonds?

Say what?

The behind-the-times image of US savings bonds is gradually being replaced by an image of a competitive investment vehicle that stays close to current interest rates. This vehicle also gives people with as little as $25 a place where they can do just as well as someone with $5,000.

Besides, they are fully guaranteed by the US government and are sold with no sales or redemption charge.

Before 1982 savings bonds had a well-deserved reputation as a poor place to save. They never paid more than 8.5 percent when money market funds were paying 15 or 16 percent.

Congress noticed the problem and now savings bonds have to pay at least 7.5 percent. But they usually pay more. The rate on Series EE bonds is recalculated every six months to keep it at 85 percent of the yield on five-year Treasury securities.

For the current six-month period running through October, EE bonds are paying 9.9 percent, says Steven Meyerhardt, spokesman for the Treasury Department's savings-bond division.

After that, the yield will reflect the overall drop in interest rates and will probably be around 8.4 or 8.5 percent, he estimates.

Still, that's not too bad. According to a recent issue of 100 Highest Yields, a newsletter that tracks savings rates at federally insured banks and thrifts, the best rate on a money market deposit account was 9 percent, but the minimum deposit was $2,500. Other yields on the newsletter's list ranged from 8 to 8.5 percent, and there were no minimum deposits below $1,000.

Competitive yields of savings bonds have ``skyrocketed'' their sales, particularly through banks and by mail, Mr. Meyerhardt says. And while Treasury prefers to tout them as a savings vehicle, they also have some useful tax advantages.

``We hadn't considered savings bonds before because the yields were so low,'' says Mary Malgoire, a financial planner in Washington, D.C. ``But now, I've become interested in them for myself.''

Interestingly, savings bonds have always followed what is currently a hot investment concept: zero coupon bonds. You pay less than the face value of the bond in the beginning, and they pay no interest until maturity, when you get the full face value representing your original investment, plus interest.

In the case of savings bonds, you pay exactly half the face value. A $50 bond, for example costs $25 and a $10,000 bond costs $5,000. In between, the denominations are $75, $100, $200, $500, $1,000, and $5,000, all purchased at half that value.

If the bonds earned only 7.5 percent, they would take 10 years to double in value, Mr. Meyerhardt said. But because they usually pay more, the doubling won't take that long.

You can buy savings bonds from almost any bank, at Federal Reserve banks, or by mail from the Bureau of Public Debt, Washington, D.C. 20226. Of course, many employers still offer payroll-savings plans where you can put part of your pay into savings bonds before you get your check.

The bonds must be held at least five years to get the 7.5 percent rate, so they should not be considered for short-term needs that might require withdrawals in a couple of months or years.

This is one reason Ms. Malgoire says, while she is personally interested in savings bonds, she isn't recommending them for her clients. ``Generally we move our clients' money around more often than savings bonds would allow,'' she explains. ``They're hard to fit into an actively managed account.''

In addition to the five-year holding period, there is also a six-month period where you can't redeem the bonds at all except in an emergency.

Whenever you redeem the bonds, all you have to do is take them to any bank and get your money. Since interest is credited only twice a year, the best time to redeem them is right after the end of each six-month period.

So do your redeeming at the beginning of May or November. If you take your money in December, for instance, you won't get any interest for that extra month.

In addition to their competitive rates, savings bonds have two tax advantages.

First, like any debt instruments issued by the federal government, their interest is free of state and local taxes.

Second, while they are federally taxed, you can defer that payment or reduce it. Unlike many zero-coupon bonds where you have to pay taxes on the accrued interest each year, savings bonds give you the choice of paying this tax yearly or paying it in a lump sum when the bond is redeemed.

This makes them particularly good for people nearing retirement. You can invest in the bonds now, when you're in a high bracket, and redeem them after retirement when your bracket is probably lower.

You can also trade Series EE bonds for Series HH bonds. That's the only way HH bonds are available.

These bonds pay only 7.5 percent interest (the rate doesn't float), but they also spin off a check for taxable interest every six months. Again, most retirees will probably find this less of problem that those in higher brackets.

If you would like a question considered for publication in this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115. No personal replies can be given by mail or phone. References to investments are not an endorsement or recommendation by this newspaper.