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Thread: Series I Savings Bonds

  1. #1
    God/dess doc-catfish's Avatar
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    Default Series I Savings Bonds

    I don't know if any of you happen to be sitting on any of these right now, but the U.S. Treasury raised the interest rate on Series I (inflation indexed) Savings Bonds to 6.73% at the beginning of the month.

    If you buy any, you would be guaranteed this rate for the next six months that you hold it. With inflation likely to continue to go up, rates could possibly go even higher during the next period (rates are set at the beginning of May and November).

    http://www.publicdebt.treas.gov/sav/sbiinvst.htm

    Unlike bank savings and CD's, the interest on I Bonds is exempt from state income tax and you can defer your federal income tax until you cash it in, or until the bond matures (30 years from the time that you buy it).

    The one catch in buying an I Bond is that your money is locked in for one year. If you cash it in less than 5 years there is a 3 month interest penalty. Not a place I would stick emergency fund money that you might need in a pinch, but if you have a small sum of cash (say $1-3K) that you can do without it for at least a year, this may be a way to go. With Christmas coming up, savings bonds also make terrific gifts for the kids.

    Would I put a lot of money into these? No, but it might be a good investment alternative to a bank CD or money market account, or a place to stick some cash if you feeling too squeamish about putting it into the stock market.
    Former SCJ now in rehab.

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    Banned Melonie's Avatar
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    Default Re: Series I Savings Bonds

    Actually, if you have a 'decent' amount of declared income, and you still plan on having a 'decent' amount of income 30 years from now, Series I savings bonds aren't all that great a deal. As with IRA's and 401k's , tax DEFERRED is not the same thing as tax exempt. The risk with tax deferred investments of course is that you may avoid paying a 28% tax rate on interest/dividend income today, but you could wind up retroactively paying a 48% tax rate 30 years from now when you cash in the investment. Series I's beat the hell out of standard savings bonds though.

    While Series I savings bonds try to sell themselves in high tax rate states because of their exemption from state tax, they're still not as good a deal as a state based muni bond fund ... which is exempt from federal tax as well as from state tax. Thus muni funds won't surprise you with a monster tax bill when you sell out, the way cashing in Series I savings bonds could.

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    God/dess montythegeek's Avatar
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    Default Re: Series I Savings Bonds

    Melonie does not mention that to do so you have to have over $325,000 per year of income in 2005 dollars. For one to earn that income half from withdrawals and half from interest and dividends one would need about 3 million dollars of assets at 7% interest rate. See http://www.irs.gov/formspubs/article...133517,00.html

    A more modest portfolio one-third that size would generate income subject to the same 28% marginal rate, but you have been compounding it without annual taxes due.

    She is correct that one can get into a "deferred income" trap, by not balancing after tax income not subject to further taxes such as state/federal tax exempt bonds and Roth IRAs.

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    Banned Melonie's Avatar
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    Default Re: Series I Savings Bonds

    Monty, your figures are based on the 2005 tax tables, not the 2035 tax tables ... which will be the tax rates in effect when the Series I bonds mature and the deferred income tax on interest earnings for the preceding 30 years comes due. Logic, demographics, and the US national debt dictate that the tax rates in 2035 will not be the same as they are in 2005, and I highly doubt that they will be going lower ! Historically speaking, the USA had a 70% top tax bracket 30 years ago ... who's to say that a 70% tax bracket can't rear its ugly head again 30 years in the future.

    IMHO making tax/investment decisions today based on assumptions that current conditions will remain in effect over a period of many future years is akin to taking out an adjustable rate mortgage at 5% initial rate or buying an SUV when gas was selling for $1.50 last year. Sure they looked like a good idea at the time, but the underlying financial assumptions have already changed to the point where you're stuck with a 'loser' for the duration (or stuck taking a loss to bail early). IRA's, 401k's and Series I bonds all involve the investor essentially 'locking themselves in' for the duration (or taking a loss to bail early), while the gov't is free to change the (tax) rules in the middle of the game. Roth IRA's and muni bond funds do not present this risk, since the gov't can't change the future (tax) rules on taxes that are already paid or on earnings that are tax free.
    ~
    Last edited by Melonie; 11-08-2005 at 08:28 PM.

  5. #5
    God/dess montythegeek's Avatar
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    Default Re: Series I Savings Bonds

    Melonie, your fears are based on your politics rather than any analysis. In fiscal 2005 Federal spending was 14.8% larger than revenues, so to completely balance the budget a 28% rate becomes 32.1. http://www.fms.treas.gov/mts/mts0905.pdf

    Excluding $200 billion for the war, spending was 5.4% above revenue and 28% goes to 29.5% (still below 6 years ago).

    The power of compounding tax free swamps either increase in marginal rates. $1000 dollars compounding at a pretax rate of 6% in a tax defered for 30 years beats a tax paying each year return by 10% even if it comes out at a 32% tax rate. In fact, the tax rate has to rise to 37% in the year just before you withdraw the first dollar to wipe out the advantage. If tax rates widen in the interim the advantage shifts even more to the tax defered account.

    The disadvantage of exempt bonds is that unless you are very rich the return is equal to less than a pretax return less your marginal rate because the people who buy them pay higher taxes,

    If one plans the future based on fear, one never saves a penny because you might die tomorrow.

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    Banned Melonie's Avatar
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    Default Re: Series I Savings Bonds

    I'll grant you that there is an element of fear in my long term future outlook towards government policies. Given rising future expenses dictated by US population demographics and 'promises' already made to currently working Americans, and faced with the dilemma of breaking promises made to older Americans (political suicide at the ballot box), versus cutting gov't spending in other areas (political suicide raising campaign money from special interests), versus raising tax rates (where 50% of lower income voters typically won't even notice), it's a very low risk bet that US politicians will choose the latter option.

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    God/dess montythegeek's Avatar
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    Default Re: Series I Savings Bonds

    ...And all those same factors would have prevented rates from having been in place from 1964 to date. The issues just change...In 1963 defense spending was 42% of the federal government and untouchable politically and marginal rates were 94%.


    Remember that the same people who pay 80% of the taxes make 90% of the political contributions.

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    Banned Melonie's Avatar
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    Default Re: Series I Savings Bonds

    Remember that the same people who pay 80% of the taxes make 90% of the political contributions.
    ... which is the primary reason that tax free muni bonds have been so popular ! It's one thing to change the tax law announcing an increase in marginal tax rates on earned income, as I clearly forsee in the near future. It's another thing to increase tax rates on capital gains, foreign income, or a host of other 'loopholes' available to people with seriously high incomes.

    As you well know, increasing tax rates on earned income primarily affects the so-called middle class far more than it affects the so-called working poor or the very rich. Not so coincidentally, voters for one major political party (the one with a long history of raising taxes on earned income) is primarily comprised of the working poor and the very rich - as well as the non-working poor who don't have to deal with income taxes at all ! I'm not intending to get political in Dollar Den, but a political pendulum swing opposite the current direction would clearly have an impact on future income tax policy, with direct consequences on future financial planning.

  9. #9
    God/dess montythegeek's Avatar
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    Default Re: Series I Savings Bonds

    Sorry Melonie, but the popular perception that you echoed does not quite hold true in the data.

    The vast lower-upper class(200K-1.5 mil AGI) where 2.0% of the 2.1% of the tax filers (who had 23% of the adjusted gross income and paid 30% of the income taxes) had 65% of their income from wages and proprietors income in 2004 (the last year for IRS income stats). The 1.7% of their income from tax exempt bonds was smaller than their rental income. They paid an average tax rate of about 25%.

    Now if you really want to raise money, you go after the folks between 100K and 200K. They make more income than those over 200K-infinity. Of course when you do that you multiply the number of peoples whose ox is being gored by a factor of 5 to 11.4 million returns or probably close to 25 million voters (or 25% of those who voted in 2004). That block would be 70% of the size of the over-65 cohort. and they have the money to back it up and magnify their numbers, Nte the groups would overlap and the income earners who pay 19K and up in taxes pay more than they get in social security.

    The people who would cry if the tax free bonds disappeared would be 1-the states who would have to pay 25% more in interest and 2 the folks who currently own muni bonds and see their investment drop 25% in value. Since I hate Teressa H Kerry, I say screw the bond holders.(personal statement about my Senator's alien(ie Pa Resident) wife who does not pay a dime of Mass. taxes not a political statement so don't jump me)

    PS all the data from the 2003 IRS Soi is at http://www.irs.gov/pub/irs-soi/03in14ar.xls and http://www.irs.gov/pub/irs-soi/03in11si.xls
    which you can get to at http://www.irs.gov/taxstats/indtaxst...,00.html#_grp1

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    Banned Melonie's Avatar
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    Default Re: Series I Savings Bonds

    Now if you really want to raise money, you go after the folks between 100K and 200K. They make more income than those over 200K-infinity. Of course when you do that you multiply the number of peoples whose ox is being gored by a factor of 5 to 11.4 million returns or probably close to 25 million voters (or 25% of those who voted in 2004)
    Yes this is exactly the group I was referring to as 'middle class', although the actual group extends downward to $70k gross income or so (and includes most serious dancers). This is also exactly the group which would bear the highest proportional brunt of tax law changes currently being discussed in Washington (eliminating state income tax deduction from federal taxes, eliminating the mortgage interest tax deduction). This is also exactly the group which would bear the highest proportional brunt of an earned income tax increase in the 'real world'.

    As you pointed out in your example, the $200k-1.5mil group actually pays a 25% real world income tax rate, even though the published rate is 36%. The difference is the result of tax planning i.e. favoring cap gains over dividends, favoring muni bonds over corporate bonds, big mortgages on second homes thus big mortgage interest deductions etc. When the earned income tax rate was much higher in the past, this group still didn't pay much more in terms of actual tax percentage, because they intensified their tax avoidance planning, and had the 'big chunks of bucks' necessary to participate in many tax favored investments. On the other hand, the $70-200k group doesn't have the same tax planning resources or 'big chunks of bucks' necessary to sidestep earned income taxes to the same degree, thus they wound up paying a higher 'real world' percentage. The gov't knows this !

  11. #11
    God/dess montythegeek's Avatar
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    Default Re: Series I Savings Bonds

    As you pointed out in your example, the $200k-1.5mil group actually pays a 25% real world income tax rate, even though the published rate is 36%.
    Sorry Melonie, the difference is the difference between Average and Marginal tax rates, the fact that these are range averages compared to average income. The marginal tax rate for the 200K-300k range was 33% in 2003 and was 35% over 312K.
    http://www.irs.gov/formspubs/article...109877,00.html

    Since the largest number of filers would have been at the bottom of the range, and all long-term capital gains are taxed at a lower rate also widens the spread, as would the credit for self-employed taxes.

    The tax planning is nulled, for the most part, by the fact that ALL comparisons are on adjusted gross income.

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    Banned Melonie's Avatar
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    Default Re: Series I Savings Bonds

    Again the larger point is being lost in the details. The IRS page you cited refers to tax rates on taxable earned income. When the tax rates on taxable earned income were/are increased, the 'rich' had/have many options open to them which allows them to 'convert' the form of income they receive away from being taxable earned income and towards being tax exempt income, tax preferred cap gains, trusts, foundations etc. which 'middle class' earners do not (or at least do not in the same proportion). This is why John & Theresa Kerry only paid a 12% real world tax rate on their 5 million dollar actual "income" last year, while most 'middle class' people paid real world tax rates over 20%. The point is that if income taxes were to again be increased to the rates which existed 30 years ago, the 'rich' would, exactly as they did back then, rearrange their financial structures to still pay a low percentage. At the same time, the 'middle class' would have much less flexibility in doing the same thing and thus would wind up paying a significantly higher real world tax rate than the 20% they pay now.

    Also, the absolute dollars comparison doesn't wash either. John and Theresa Kerry having to pay an extra $50,000 in taxes in the future will not change their $5 million dollar lifestyle. On the other hand, having to pay an extra $10,000 per year in taxes in the future is extremely significant to a 'middle class' person whose total after tax income is under $100k. The effect is even further amplified when a 'middle class' person defers the taxes due on Series I bond, 401k, IRA earnings etc. such that taxes on 30 years worth of interest income all come due in a single year 30 years down the road.

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    Default Re: Series I Savings Bonds

    So, are you two married already, or still planning it

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    Default Re: Series I Savings Bonds

    Federal bonds carry less risk than munis. Municipalities can go bankrupt, Fed can always print more money, ie no default risk. Both are susceptible to interest rate and inflation risk. Some munis are taxable. If you are looking for triple tax exempt, try US territory muni. There is a simple formula to calculate what your rate of return will be with a tax-free bond versus taxable based on your bracket.

    Federal bonds are safe instruments to add to your fixed assets portfolio, but I wouldn't expect too much out of them due to the volatile nature of L-T maturity bonds.

    I definately wouldn't use them as an alternative to liquidity reserves or equity assets. Allocate! Allocate! Allocate!!

    Btw, this is just fun free practice advice to doc, this is not financial advice from a licensed advisor. I can't even deal with analyzing Melonie/Monty. The solution Doc is looking for shouldn't be so complex.

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    Default Re: Series I Savings Bonds

    So, are you two married already, or still planning it
    hmmm ... I'll have to let Monty run the math on 'married filing separately' tax rates LOL

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    Default Re: Series I Savings Bonds

    Quote Originally Posted by Melonie
    hmmm ... I'll have to let Monty run the math on 'married filing separately' tax rates LOL

    That would be hot!

    "Have you ever been to American wedding? Where is the vodka, where's marinated herring?" - GB
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