U.S. Savings Bonds – The Safe Place to Save Money
Safe Savings Vehicle or Underperformer?
If you’re tired of the pitiful interest rate on your savings account at the bank, you may want to look into U.S. savings bonds for an equally safe place to keep some of your savings. With most bank accounts, the safety of your money comes from being insured by the Federal Deposit Insurance Corporation, or FDIC. This provides insurance on up to $100,000 per depositor. Unfortunately, while your money may be safe, there is a good chance the interest rate on the account is quite low.
With U.S. savings bonds, your money is also safe, but it isn’t through FDIC insurance. Savings bonds are backed by the full faith and credit of the United States government. For individuals who are seeking safety of their principal, they can rest easy knowing that as long as the government is around, they are obligated to repay your principal and interest.
Tax Benefits of Savings Bonds
Because savings bonds are issued by the federal government, they are exempt from state and local taxes. In addition, the interest earned on bonds can be tax-deferred until the bond is redeemed. This is unlike interest earned on regular savings accounts and certificates of deposits where the interest earned is taxable fully as ordinary income each year. If you’re concerned about taxes, savings bonds can provide some relief.
Series EE Bonds
The EE bond is the standard savings bond and they replace the earlier E bonds which are no longer issued by the U.S. Treasury. Series EE bonds purchased on or after May 1, 2005, earn a fixed rate of interest. This allows you to easily calculate what your bonds are worth at any given time. EE bonds that were purchased between May 1997 and April 30, 2005, earn interest based on a 5-year variable market-based yield.
EE bonds can be purchased directly from Treasury Direct Online. Electronic bonds are sold at face value, which means you pay $25 for a $25 bond, and it is worth its full value when it is available to be redeemed. These bonds can be purchased for any dollar amount of $25 or more. The maximum purchase per calendar year is $5,000.
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 and the bond does not reach face value until it has matured. Also, you may only purchase paper EE bonds in pre-determined denominations: $50, $75, $100, $200, $500, $1,000, $5,000, and $10,000. The maximum purchase amount per calendar year is also $5,000.
It is also important to note that if you redeem a series EE bond any time during the first five years, you’ll forfeit the three most-recent months’ interest. Redeeming an EE bond any time after five years will not incur a penalty. In addition, you must wait at least one year before redeeming an EE bond.
Series I Bonds
I bonds are similar to EE bonds, but they have a distinct difference in determining how much interest is paid. The I stands for “inflation”, and series I bonds have an interest rate that is 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 semi-annual inflation rate on top of that. The inflation rate is determined once in May and again in November.
Just like EE bonds, you may buy a paper I bond or purchase electronically. The same limitations apply except that all I bonds are sold at face value and you can only purchase $5,000 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?
The interest rates on bonds changes over time as other key economic interest rates fluctuate, but EE bonds issued between November 2007 and April 2008 earn 3.0%. To put this into perspective, going back to 1995, the long-term rates ranged between a low of 2.47% in 2003 to a high of 6.31% in 1995. A comparable I bond rate after November of 2007 earns 4.28%.
Bonds for Higher Education
With the introduction of Section 529 college savings plans, using savings bonds for higher education savings has become less attractive, but they do still hold some advantages. For EE and I bonds issued after 1989, the bond owner can redeem the bond without being subject to federal tax on the interest, provided the higher education expenses are qualified.
In addition to having qualified education expenses, you must be at least 24 years old on the first day of the month in which you purchased the bond. If the bond is for your child, they must be registered in your name and your child may be listed as a beneficiary, but not as co-owner. The IRS also imposes income limitations for which 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 place to save money, but you want to make sure that you’re putting money into bonds for the right reasons. Remember, the interest rates can be higher than a typical savings account, but there may be some liquidity concerns to contend with first. If there is a chance you may need access to the money inside of one year, keep in mind that you cannot redeem a savings bond until one year has elapsed. In addition, you will forfeit three months’ interest if you redeem a bond prior to five years.
Even with interest rates generally higher than your bank account, savings bonds should not make up a significant portion of your long-term savings. Compared to other long-term investments like stocks in your retirement account, the interest earned is quite low. Stocks historically return between 9-11% on average per year, so investing for your future solely in savings bonds will probably not yield the best results.
Savings bonds should be considered for financial goals somewhere between five and ten years away. After five years you may redeem the bonds without penalty, but hanging onto bonds for much longer than ten years and you could probably see better returns with other investments.