Savings bonds draw inquiries

I received a flood of phone calls and e-mails after my recent column about the 6.73 percent interest rate on inflation-indexed U.S. savings bonds. So here are answers to some of the common questions:

Q: How much can you invest?

A: An individual can purchase up to $60,000 worth of savings bonds a year. For that, you’d have to divide your purchase. You can invest up to $30,000 through a financial institution – generally a bank – and $30,000 directly with the government, at www.treasurydirect.gov or by calling (800) 722-2678.

Q: Are interest earnings compounded?

A: Yes, interest is compounded semiannually. Interest is not paid out at regular intervals as it is with ordinary bonds and bank savings. Rather, it accumulates and is received when the bond is cashed in.

Q: Can you lose principal?

A: No, you cannot, even if you cash in the bond early. A savings bond is redeemed directly from the government or a bank acting as the government’s agent.

In contrast, many other types of bonds, including U.S. Treasury bonds, can be converted to cash before they mature only by selling to another investor in the secondary market. Investors will not offer full price for an older bond if it pays less interest than a newer one. With savings bonds, the investor does not face this “interest-rate risk” because the bonds are not traded on the secondary market.

Q: How can savings bonds be used to pay for college, tax-free?

A: In addition to the exemption from state and local taxes, the bonds’ interest earnings can be exempted from federal income tax if used for qualified education expenses – generally tuition. Parents are the most likely to qualify for this exemption.

To get it, the student must be the bond owner or spouse of the owner, or a dependent claimed on the owner’s federal income tax return. The owner must be at least 24 years old before the bond’s issue date, and must have a modified adjusted gross income below certain limits – about $75,000 for individuals, $120,000 for couples filing joint returns.

MAGI is adjusted gross income, calculated on the federal return, with certain items added. For details on this and other issues concerning the education exemption, get IRS Publication 970 at www.irs.gov/pub/irs-pdf/p970.pdf, or call (800) 829-3676.

Q: Can EE bonds be exchanged for I bonds?

A: No. But you can redeem the EE bonds and use the proceeds to buy I bonds.

In case you missed that column, I’ll recap some of the key points about I bonds.

The current 6.73 percent annual interest rate is good for the first six months you own the bond, and it’s only for the bonds sold from Nov. 1 through the end of April 2006.

After the first six months, the rate will be adjusted. The variable portion of the rate will be set to match inflation. That will be added to a fixed portion to determine the total rate.

The fixed rate on bonds being sold through the end of April is 1 percent. That will stay the same for the bonds’ 30-year life. The current variable rate is 5.73 percent, and that can go up or down every six months throughout the bond’s 30-year life.

Savings bonds cannot be redeemed until they have been owned for 12 months, and if they are cashed in within the first five years, you lose the final three months’ interest earnings.