Savings Bonds. You hear about them all the time, usually in the context of an award for spelling bee or a gift from grandma, but are savings bonds in fact a good option for saving and investing?
I did a little research on savings bonds (and even bought some) and this is a summary of what I learned.
First of all, what are savings bonds? They're essentially loaning money to the US Government and have them pay you interest. Along with CD's they are one of the most conservative forms of investing.
There are two major types of savings bonds that I looked into.
Note this info applies to newly purchased savings bonds. The rules for savings bonds have changed over the years so if you have an older saving bonds and you are trying to figure out its value, I would suggest taking it to a bank.
Series EE Bond:
The Series EE bond is a savings bond that you purchase for half of the face value. So if you pay $50 you get a bond that says $100 on it. The interest rate for the bond is fixed at the time of the bonds purchase and never changes for the bond. Also a bond has a maturity term of 20 years. That means that if you hold the bond for 20 years it is guaranteed to double in value.
So you are probably wondering..what if the interest rate on the bond is such that in 20 years the interest hasn't doubled the value of the bond? Well the answer is that the treasury department will make a one-time adjustment to the value of the bond at 20 years making it equal to its face value if the interest over the 20 years hasn't already gotten it there.
After 20 years the bond continues to accrue interest at the fixed rate for another 10 years. After 30 years the bond ceases to earn interest.
Series I Bond:
The Series I Bond is a bond that you purchase at face value (you pay $25 and you get a bond that says $25 on it).
The interest rate on an I Bond is called a composite rate because it's partially fixed and partially variable. The fixed rate is set when you purchase the bond, the variable part of the rate is based on inflation and is recalculated by the US Government every May and November.
The composite rate of an I Bond is determined by an odd formula:
Composite rate = Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)
So the current fixed rate on an I Bond is: 1.3%, and the current inflation rate is: 1.21%. So this means:
Composite rate = [0.0130 + (2 x 0.0121) + (0.0130 x 0.0121)]
Composite rate = [0.0130 + 0.0242 + 0.0001573]
Composite rate = [0.0373573]Composite rate = 0.0374
Composite rate = 3.74%
So notice that if inflation goes up a lot, the interest rate of your bond will go up as well. The idea is that with an I Bond your return will never be outpaced by inflation.
Tax Benefits of Savings Bonds:
Two interesting tax benefits of savings bonds of are that you only pay federal income taxes on the interest you make on the bond (no state taxes). You only pay the taxes when you redeem the bond.
Another interesting point of savings bonds is that:-------------------
The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross income all or part of the interest paid upon the redemption of eligible Series EE and I Bonds issued after 1989, when the bond owner pays qualified higher education expenses at an eligible institution.
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The above paragraph (as well as other criteria you have to meet to take advantage of this) can be found at:
http://www.treasurydirect.gov/tdhome.htm
This page also has all of the info on rates and you can even order the form to buy bonds (or you can just go to any bank or credit union and get the form there).
So I bought some I Bonds and they have been...fine. Very safe, not exciting returns. My view on savings bonds after going through the experience is that:
I-Bonds would be interesting if the fixed rate ever goes up to a significant value.
The EE bonds really don't excite me that much.
So if you have some money and want to buy some savings bonds, there certainly isn't much risk involved, but I find it hard to find a compelling reason to invest in them.
Though they do make nice gifts for the grandkids.
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