Viewer Question: Emergency Savings: Bank Account or Savings Bonds?

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In an emergency, should you use the money in your savings account or cash in your savings bonds?

Viewer Question from Robert:

I enjoy your segments was wondering if you could offer me some advice.

There is a 50/50 chance I will be out of a job come January 1st. (new management) I am considering cashing in some savings bonds to cover monthly expenses until I can find a new job. I am unsure if unemployment matches what I make not or now.  I have heard from others that cashing in savings bonds will increase the amount of taxes I have to pay. (why does the govt. penalize those who save?)  Would my unemployment count as taxable income? Do you know if a 3-4 month period of unemployment would lower my income enough to avoid paying more in taxes?

I am in fair shape economically.
I make about 25k a year
I have 10k in regular savings acct (dont want to touch), 8k equity on a 38k house (10 yr loan)
no car payment,  school loans, credit card paid off monthly
bare monthly living expenses around $800/mo ($300 less if i get a new roommate) [doesnt include materials to finish house]
Robert

Hi Robert,

First, let me congratulate you on at least two fronts: first, for being a great saver. And second for thinking and planning ahead. Both of these characteristics are in short supply these days!

What I’d recommend first is for you to find out how much you can expect in unemployment and if that will be enough to live on. The first $2,400 of your benefits might be tax free (they were in 2009: see http://www.irs.gov/newsroom/article/0,,id=205633,00.html ) I’m not sure if that benefit will extend into 2010: if it doesn’t, they’ll be fully taxable.

As for whether to use your savings bonds or your savings account as your emergency fund: there are several things to look at to help you decide, one of which you’ve mentioned: the taxability of your savings bonds. If you do cash them in, you will owe taxes on the interest they’ve earned over the years. (This isn’t really the result of the government penalizing saving: it’s just that since you don’t pay taxes as the bonds earn interest, you’ve got to pay it when you cash them in.) You’ll be in a low tax bracket, of course, but still: pulling money from your 10k savings account won’t cost you anything in taxes, so that may be the better bet.  Another thing to consider is whether your savings bonds are earning more interest than your savings account: my guess is that they are. Which means using the savings account first is again the better option. The third criteria is if there are any penalties to cash in your savings bonds. If you’ve had them for less than one year, you can’t cash them in. Less than five years, you’ll pay a 3-month interest penalty to cash them in.  To see exactly what your bonds are currently worth, go to http://www.treasurydirect.gov/indiv/tools/tools_savingsbondcalc.htm

All in all, odds are good that you’ll be better off using your savings account first, then cashing in your savings bonds should the need arise.

Hope that helps, Robert.  And we’ll certainly hope that none of this information will prove necessary: good luck!

Stacy Johnson

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