U.S. Savings Bonds The Safe Place to Save Money

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.

Electronic EE Bonds

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.

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 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.