Savings Bonds Lose Interest Safety Net May 1 Floating Market-Based Rates To Replace 4 Percent Floor

If you’re in the market for United States savings bonds, should you buy them before or after the government changes the rules on interest rates next month?<> The answer depends on how long you plan to hold the bonds.

On May 1, the government will make several changes concerning the Series EE savings bond.

The guaranteed minimum interest rate on the bonds, now 4 percent, will be replaced by market-based rates and interest will be credited to all bonds semiannually.

For investors who hold bonds more than five years, the Treasury’s change is not good news.

Under the new program, these long-term bonds will earn interest equal to 85 percent of the average yield that five-year Treasury securities earned during the period the bond was held. (That yield is now 6.93 percent.)

Under today’s rules, however, investors can earn either that rate or the 4 percent guaranteed minimum, whichever is higher.

In other words, the new rules take away the safety net that long-term bond investors now have, with no offsetting advantage. Thus, for longterm investors who plan to buy bonds soon, the smart move is to pull out your wallet before May 1.

For investors who hold savings bonds for less than five years, the new rules may outshine the old. But there are two big “if’s” - one for conservative investors, one for forgetful ones.

Currently, these short-term bondholders receive the 4 percent guaranteed rate if they cash in from six months to five years after purchase. (For less than six months, buyers receive no interest.)

After May 1, these investors will get a market-based rate equal to 85 percent of the average yield that sixmonth Treasury bills earned during the bonds’ life.

At today’s rates, this change can really notch up returns. Six-month Treasuries now yield 6.09 percent, for instance, and under the 85 percent calculation a short-term investor would earn 5.17 percent - about one percentage point more than the guaranteed minimum.

But remember that the 4 percent floor has collapsed under the new rules. If interest rates fall far after May 1, there will be nothing to stop a short-term investor’s returns from doing the same.

Here’s the second “if.” Under both the old and new rules, investors who hold savings bonds for more than five years get interest credited every six months, in the month the bond was bought and six months later. Thus, unwary long-term investors can lose up to a half year of interest with poorly timed sales.

The new program will extend this perilous semiannual schedule to bonds held less than five years.