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Series EE Savings Bonds (and their forerunner, Series E Bonds first issued in 1941 and replaced by Series EE Savings Bonds in 1980) have been promoted by the United States Government(1) and others(2) as an excellent investment for individual savings. Effective January 1, 1990, the government has offered the additional possibility that interest earned can be totally free of federal income tax if the proceeds are used to fund certain college expenses. Some investment advisers now believe that Savings Bonds are an attractive way to save for this major expenditure.(3)
Fifty years of heavy promotion have attracted substantial funds to the U.S. Treasury. As of March 31, 1991, there were $127.7 billion of E, EE, H, and HH Savings Bonds outstanding versus nearly $1.6 trillion of other long-term U.S. treasury securities.(4) Approximately $8.1 billion of Series EE Bonds were sold during 1990.(5) More than six million people now buy Savings Bonds through payroll-savings plans.(6) Considering the recent changes in Savings Bonds, a detailed financial analysis of their attractiveness as an investment vehicle for a number of savings goals is timely.
The first section below reviews the operational details of Savings Bonds. The next section evaluates the financial attractiveness of bonds for achieving various savings goals. Specific strategies regarding the purchase and redemption of Savings Bonds are in the following section, and a summary and conclusions are offered in the last section.
OPERATIONAL DETAILS OF SAVINGS BONDS
Savings Bonds are undoubtedly convenient, simple, safe, and affordable investments. As almost everyone knows, the interest earned on Savings Bonds is not paid out on a periodic basis; but rather, interest accrues and increases the value of the Bond. Tax law allows the cash basis owner of the Savings Bond the option of choosing to defer the taxability of the interest income until the Bond is redeemed or to declare the accrued interest annually as taxable income. However, once the taxpayer elects to report the interest each year, the taxpayer must continue to do so for all Series EE or Series E Bonds owned and any acquired in the future, unless permission to change is granted by the IRS. Because of the advantage of deferring the payment of tax, the vast majority of Savings Bond owners choose to...