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Dr. Don Taylor, CFA, Bankrate.com advice columnist What to do with inherited savings bonds

Dear Dr. Don,
My father passed away a while back. In addition to inheriting his IRAs and 401(k), he also left me a substantial amount in U.S. savings bonds. My father purchased the savings bonds about 16 years ago, so they have accrued a substantial amount of interest. The current yield on the bonds is 4 percent.

I feel that although the bonds are a very secure investment vehicle, the interest rate is far too low. I was considering cashing out the savings bonds and placing them into more aggressive investment vehicles, like stock-based mutual funds.

That's where my question and concern come up. If I cash out the savings bonds, I'm concerned I'll pay a hefty amount of taxes. I make a good salary, and I have maxed out my 401(k) contributions.

What would be the best scenario for me?

  1. Cash out the savings bonds and move them into more aggressive investment vehicles.
  2. Keep the savings bonds until maturity, but place my other investments in more aggressive vehicles -- like international and small cap mutual funds.
  3. Keep everything as is.

Thanks for your advice,
-- Joe

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Dear Joe,
Key in all of this is to make the decision that's right for the overall portfolio and to not look at the savings bonds in isolation. Also key is how the bonds were registered and if your father's estate paid any of the tax bill on the interest income.

It's possible that your father's estate reported the interest income up to the date of his death and the estate's federal income tax return paid those taxes. Talk to your tax adviser if you're not certain about what was done about the interest income earned from purchase up to the date of death. The Treasury Direct Web site page, titled "Death of a Savings Bond Owner," has more complete tax information.

If no taxes were due, then the tax-deferral feature of these bonds keeps more money at work earning 4 percent than you can put to work after redemption and taxes only to earn 5-plus percent in a money market account. There's also the consideration that there's no state or local income taxes due on the interest earnings, which makes holding these bonds until maturity a little more attractive than you'd think at first blush.

Holding on to the savings bonds and changing the investment mix of your other accounts can make sense if there's not a big tax impact from those changes and you're willing to continue owning these savings bonds yielding 4 percent. It's easy to adjust your holdings in tax-advantaged accounts without creating a big tax obligation.

It sounds like you're managing enough personal wealth that you shouldn't be trying to do it yourself. Find a fee-based financial planner to help you sort through these issues. An earlier Dr. Don column, "Picking a financial adviser," can help you find that planner.

Bankrate.com's corrections policy-- Posted: May 11, 2007
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