U.S. Savings Bonds—A Safe Place to Save Money
Safe Savings Vehicle or Underperformer?
You might want to look into U.S. savings bonds if you’re tired of the interest rate you're getting on your savings account at the bank. Bonds are an equally safe place to keep some of your savings, but they do have their pros and cons.
Savings Bonds vs. Savings Accounts
The safety of your money in most bank accounts comes from being insured by the Federal Deposit Insurance Corporation (FDIC). This provides insurance on up to $250,000 per depositor as of 2018. While your money might be safe in a savings account, the interest rate is likely quite low.
Your money is also safe in U.S. savings bonds, but not through FDIC insurance. Savings bonds are backed by the full faith and credit of the U.S. government. Individuals who seek the safety of their principal can rest easy knowing that as long as the U.S. government is around, it's obligated to repay principal and interest on savings bonds.
If you’re concerned about taxes, savings bonds can provide some relief. Savings bonds are issued by the federal government so they're exempt from state and local taxes. In addition, the interest earned on bonds can be tax-deferred until the bond is redeemed, unlike with regular savings accounts and certificates of deposit, where interest earned is taxable fully as ordinary income each year.
Series EE Bonds
The EE bond is the standard savings bond. It replaces the earlier E bonds, which the U.S. Treasury no longer issues. Series EE bonds purchased on or after May 1, 2005, earn a fixed rate of interest, so you can easily calculate what your bonds are worth at any given time.
You’ll forfeit the three most recent months’ interest if you redeem a series EE bond any time during the first five years, but redeeming an EE bond at any time after five years will not incur a penalty. You must additionally wait at least one year before redeeming an EE bond.
Purchasing Series EE Bonds From Treasury Direct
EE bonds can be purchased directly from Treasury Direct Online. Electronic bonds are sold at face value, which means that you'll pay $25 for a $25 bond. The bond is worth its full value when it's redeemed, plus accumulated interest.
These bonds can be purchased for any dollar amount of $25 or more. The maximum purchase per calendar year is $10,000 as of 2018.
Buying Paper EE Bonds
Unlike the electronic version, paper EE bonds are sold at half their face value. For example, you would pay $25 for a $50 bond. The bond then increases in value over time as interest is earned. The bond doesn't reach face value until it has matured, but the Treasury guarantees that a bond will be worth double its face value in 20 years if it was purchased after 2003.
You can only purchase paper EE bonds in predetermined denominations: $50, $75, $100, $200, $500, $1,000, $5,000, and $10,000 as of 2018. The maximum purchase amount per calendar year is also $10,000.
Treasury Direct Pros and Cons
If you're like many people, you might find it difficult to keep track of scraps of paper, even important papers, over stretches of several years. One of the advantages of buying through Treasury Direct is that you won't have to. Treasury Direct "stores" your bonds for you. Just go online and access them when you want them.
The site is super secure as well, so no one else should be able to do access your bonds without your approval, knowledge, and cooperation. You'll need a password and a security code to log in.
Finally, you don't have to make a trip to the bank when the time comes to redeem your bond. Treasury Direct sends the funds directly to your bank account. You should have the money within two to three days. How easy is that?
However, if you depend on quarterly or annual statements to help you keep your finances in order, you won't get these from Treasury Direct. The system will, however, make sure you have all necessary tax documents.
Series I Bonds
I bonds are similar to EE bonds, but there's a distinct difference in how much interest they pay.
The "I" stands for “inflation." Series I bonds have an interest rate that's indexed to the inflation rate. This means that your I bond is designed to keep pace with—or beat—inflation. The actual interest rate is set by a fixed rate that lasts the life of the bond plus a semiannual inflation rate on top of that. The inflation rate is determined once in May and again in November.
Just like EE bonds, you can buy a paper I bond or purchase one electronically. The same limitations apply except that all I bonds are sold at face value. You can only purchase $10,000 in I bonds per year. You will also forfeit the three most recent months’ interest if you redeem an I bond within the first five years.
What Interest Rate Do Savings Bonds Pay?
Interest rates on bonds change over time as other key economic interest rates fluctuate. EE bonds issued between November 2018 and April 2019 earn a fixed annual rate of .10 percent. A comparable I bond will earn a composite rate of 2.83 percent as of November 2018.
Bonds for Higher Education
Using savings bonds for higher education savings has become less attractive with the introduction of Section 529 college savings plans, but they do still hold some advantages. Owners can redeem EE and I bonds issued after 1989 without being subject to federal tax on the interest if the funds are used for qualified higher education expenses.
You must be at least 24 years old on the first day of the month in which you purchased the bond to qualify. Bonds must be registered in your name. Your child can be listed as a beneficiary but not as co-owner if the bond is for your child.
The IRS also imposes income limitations affecting when this tax exclusion can be claimed. See IRS Form 8815 for current income limits.
When Are Savings Bonds Appropriate Investments?
U.S. savings bonds are certainly a safe way to save money, but be sure you’re putting money into bonds for the right reasons. Remember, the interest rates can be higher than a typical savings account, but there can be some liquidity concerns. If there's a chance you might need access to the money inside of a year, this could present a problem.
Savings bonds should not make up a significant portion of your long-term savings. The interest earned is quite low compared to other long-term investments like stocks held in your retirement accounts. Stocks historically return about 10 percent a year over time, so solely investing in savings bonds will not likely yield the best results.
Savings bonds should be considered for financial goals somewhere between five and 10 years away. You can redeem the bonds without penalty after five years, but you could probably see better returns with other investments if you plan on hanging onto bonds for much longer than 10 years.