Savings bonds' popularity soars, but there are some drawbacks


NEW YORK--Is it patriotism? Is it fear of banks? Is it the 7.2 percent interest rate? Is it the tax break for college tuition? Whatever the lure, Americans bought more U.S. savings bonds in January than in any other January since World War II.

Sales of Series EE bonds have been increasing steadily since last July. In December, sales jumped 17 percent. The near-record January brought in $953 million, close to the $1.1 billion purchased in January, 1944.

The current rate of interest lasts until April 30, after which it will be reset. Series EE bondholders get 85 percent of the average yield on regular, five-year Treasury securities, with the rate changing every May 1 and Nov. 1.

Savings bonds purchased today can't earn less than 6 percent, compounded semiannually, as long as you hold them for at least five years. And they might earn more, depending on what happens to market rates.

But not all reasons for buying savings bonds are equally sound.

Take the safety issue. Savings bonds are no safer than a federally insured bank account. It's true that the bank insurance fund might run out of money. But by law it's 100 percent backed by the U.S. Treasury -- just as savings bonds are. So both bonds and bank accounts share the same guarantee.

And take the interest rate. If current market trends continue, the rate you're earning on your savings bond will drop May 1, to about 6.5 percent or less.

Maybe it will rise again over the time you hold the bond; then again, maybe it won't.

If you cash in the bond before five years are up, you won't even get 6 percent, let alone 7.2 percent. You'll be paid anywhere from 4.16 to 5.75 percent, depending on how long you kept your investment.

A straight five-year Treasury note bought through a discount broker, by contrast, might net you a firm 7.3 percent (after sales charges) for each of the next five years.

Finally, take the tax break for college savings. If a parent age 24 or older buys a savings bond and cashes it in to pay for college tuition, no income taxes are due on the interest earned -- provided that the parents' joint taxable income (including the value of the redeemed bonds) doesn't exceed the equivalent of $62,900 in 1991.

That figure rises each year with the inflation rate. If your income is higher, the tax break gradually phases out, vanishing entirely at an income level of $94,350. For single parents, the cutoff points are $41,950 and $57,700.

But the cost of college has been rising by 8 percent to 9 percent a year, which is more than you're earning on your savings bonds. So your savings might pay less and less of the college bill each year.

The most likely way of making your college savings grow, after inflation and taxes, is to buy a no-load, stock-owning mutual fund and hang on for at least ten years.

One other point: You don't even get the tax break if the savings bond is owned or co-owned by the child, or if a grandparent buys the bond.

But savings bonds do have some advantages:

* You can earn 7.2 percent currently on a small amount of money. The cheapest bond costs $25.

* You can defer taxes on the interest until the bonds are cashed in.

* You receive no money until redemption, so you can't go out and spend the interest. In this respect, savings bonds force you to save.

You can buy Series EE bonds through many banks and S&Ls;, Federal Reserve banks or branches, or payroll-deduction plans at work.

For a free guide, send a postcard (not a letter) asking for "The Savings Bonds Question and Answer Book," Office of Public Affairs, U.S. Savings Bonds Division, Dept. WG, Department of the Treasury, Washington D.C. 20226.

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