By JANE BRYANT QUINN
If you hear about one more complicated investment choice, you may feel like throwing this newspaper across the room. But I have to tell you. Starting Sept. 1, you'll be offered a new type of U.S. Savings Bond.
It's an inflation-linked investment, dubbed a "Series I" Bond. These bonds will protect your purchasing power in any economic environment. They'll pay a fixed return on top of inflation, no matter how high inflation goes.
The fixed return will probably run between 3 percent and 3.5 percent, depending on the state of the market when you buy. This fixed rate will be added to the average inflation rate, to determine your current yield.
Say, for example, that an I bond's fixed, annual yield is 3.25 percent and inflation is 1.5 percent. Together, they'll give you an annualized yield of around 4.75 percent.
The inflation-linked portion of your rate changes every May 1 and November 1. But the fixed portion of the rate remains the same for as long as you hold the bond.
Contrast this with traditional Series EE Savings Bonds. The entire rate on Series EEs adjusts every May 1 and November 1, in line with the general level of interest rates. EE bonds can also keep you ahead of inflation, but not reliably so.
Series I bonds will yield a bit less than Series EE bonds when you buy them new. That's the price you pay for the guarantee that inflation won't touch your real, fixed return, says Deputy Treasury Secretary Lawrence Summers.
Savings-bond expert Dan Pederson looked at how I bonds might have behaved in the past, compared with EE bonds. He concluded that the two would have yielded about the same, if the fixed return on the I bonds were 3.25 percent.
At the current, low rate of inflation, however, it would take a fixed yield of 3.75 percent for I bonds to return the same as an EE bond today, he says.
A discussion of I bonds will be included in the next edition of Pederson's book, "Savings Bonds: When to Hold, When to Fold and Everything in Between." It will be published in November. Pre-publication price: $17.95 (call 800-927-1901). In November, it will sell for $22.95, including shipping.
Conservative savers should take note: Series I bonds, with real returns in the 3 percent range, yield more than short-term Treasury bills, says John Brynjolfsson, vice president of Pacific Investment Management Co. (PIMCO) in Newport Beach.
No income taxes are due on your savings-bond earnings until the bonds are redeemed. At that point, you pay only federal taxes, no state or local taxes.
An individual can buy up to $30,000 in I bonds every calendar year. In addition, you can buy up to $15,000 of EE bonds. The financial institutions that handle EE bonds will handle I bonds, too.
Series I bonds will be priced in a more understandable way than EE bonds are. With EE bonds, you pay half the face value. For example, a $100 bond costs $50. You earn interest on the $50, which is added to the value of the bond. It can take as many as 17 years for the bond to equal its face value (the exact length of time depends on the level of interest rates).
Many EE-bond buyers think there's a penalty for redeeming the bonds before 17 years are up. There's not. The early redemption penalty (of three months' interest) lasts only for the first five years.
You won't make that mistake with I bonds. These bonds will be sold at face value. A $100 bond will cost $100, and gradually gain in value as interest accrues. That's a much clearer way of showing what you've earned.
Alternatively, you can buy inflation-indexed Treasury securities (minimum investment: $1,000, maturing in five, 10 or 30 years). These Treasuries make a fixed payment, semiannually; you also get an inflation adjustment that builds up in the bond until it's sold. Indexed Treasuries generally yield more than Series I bonds will, Brynjolfsson says.
The inflation adjustment on Treasury securities is taxable every year (unlike Series I bonds, which are tax deferred). So the Treasuries are best owned in a tax-deferred retirement account. The best way to buy: through a Treasury Direct account at the nearest Federal Reserve bank or the Bureau of the Public Debt, 202-874-4000.
Roth tax break
Everyone who owns a traditional Individual Retirement Account is asking the same question: Should I switch the money into the new Roth IRA? You can do it if your adjusted gross income doesn't exceed $100,000, married or single.
If you're going to make the switch, this should be the year. That's because you get a tax break.
Normally, money shifted from an IRA to a Roth will be taxed as current income. In 1998, however, you can spread that income over four years. That spreads out the taxes, too. (In any year, the income from the IRA conversion doesn't count toward your $100,000 ceiling.)
If you're close to the top of your tax bracket range, this phantom IRA income could push you into a higher bracket possibly making the shift undesirable. If your children are in college, the apparent rise in your income might cost you some student aid.
Nevertheless, there are many advantages to a Roth: If you work past 70-1/2, you can continue to contribute. You don't have to make withdrawals, at any age. The Roth can be left to your heirs, income-tax free, if you've held it for at least five years. Withdrawals are tax free, if you're over 59-1/2 and have held the Roth for at least five years.
If you're being taxed on your Social Security benefits, consider converting part of your IRA to a Roth. That lowers your mandatory IRA withdrawals, and might cut your income by enough to reduce or eliminate this tax.
If you've already entered the year in which you turn 70-1/2, you can't escape your first, mandatory IRA withdrawal. But you can switch the rest of your IRA into a Roth.
Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.
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