Net-Savvy Savings Bond Investing

The US Treasury's savings bonds (see their home page here), offer a unique set of benefits for the individual investor. These benefits are even greater when leveraged through the use of the internet. They include: 

• Reasonable return for a no-risk investment.  I-Bonds bought until 04/30/2007 pay 4.52% for the next six months, while EE "Patriot" bonds are paying 3.60%  fixed.  
• No commissions or transactions costs. They can be purchased directly online from the US government, and they will be mailed to you for free; alternatively, you may buy them at virtually any bank branch with no fees.
• As liquid as cash after 11-12 months. They can be redeemed for cash at just about any financial institution any time in the sixth month after the month of purchase or later. (So, a bond purchased on January 30 may be redeemed starting January 1 of the following year.)  Note that redemptions within five years of purchase incur a penalty equal to three months' worth of interest.
• Very favorable tax treatment.  You don't owe any Federal taxes on the accrued interest until the bonds mature or you redeem them for cash. So the federal income-tax bill on your savings bond interest can be deferred as long as you choose (up to 30 years when they mature.) Also savings bond interest is completely exempt from state and local income taxes.  Finally, if you use the proceeds from a bond for educational expenses, they may be totally tax free.  (See http://www.savingsbonds.gov/sav/saveduca.htm )
• Available even in very small denominations. $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000 savings bonds are available.  If you think you might need some of the cash in, say, 12 months, but would like to defer taxes no the rest, simply buy multiple smaller-denomination bonds and you can redeem them in smaller quantities as needed.  Or, buy a smaller denomination i-bond as a gift for a child.  They can track the growing value of their investment online, and learn about the benefits of saving, what inflation means, etc.
• Option of Inflation protection. I-Bonds earn a fixed rate PLUS the going rate of inflation, adjusted every six months. (EE bonds offer no such adjustment.)
• Credit card purchases are no longer available. Previously, if you had purchased a savings bond direct from Uncle Sam, you can use any major credit card and it would be charged as a purchase, not a cash advance.  That meant that (a) you get cash back, frequent flyer miles, or any other bonus your credit card may give you for purchases, and (b) if you pay your balance in full each month, you'll get from 25-55 days of free "float" between the time you buy the bond and the time the credit card bill is due that month. Alas, that huge advantage is now gone.
• Easy determination of the bond's value at any time.  To see what the bond is worth at any given time, just input the basic information into the U.S. Savings Bond Calculator . 

Types of Savings Bonds: I-Bonds and EE "Patriot" Bonds

I-Bonds The I-Bond is a savings bond that is adjusted for inflation ever six months.  To do this, its interest rate is composed of two separate rates: 1) a fixed rate of return, determined by the issue date of the bond, that applies for its entire life (30 years or redemption, whichever comes first), and 2) a variable rate of return equal to the current inflation rate. Both rates are recalculated semiannually, each November 1 and May 1. The fixed rate is combined with the current variable rate to determine the overall I Bond interest rate to be paid over each six-month period. Interest then accrues monthly and compounds twice a year. In computing the fixed part of the rate, the I-Bond's principal is increased to account for inflation. Granted, this can be confusing! 

EE or "Patriot" Bonds EE bonds are standard savings bonds, not adjusted for inflation. As of May 1997, the rate for EE bonds is adjusted every May and November 1, and is based on an entirely mechanical formula: 90% of the average yields on 5-year Treasury securities for the preceding six months.  EE bond interest is always updated semiannually, based on the month of purchase.  Thus, Any EE bond purchased on or after May 1 but before November 1 will accrue interest at the rate announced that May for a full six month period, at which point November's rate will then apply for the next six months.

The combination of safety,  liquidity, and possible tax advantages make savings bonds a unique option. Particularly if you have no need for the money you invest for 11-12 months, While recent policy changes have reduced their attractiveness somewhat, there are perhaps no zero risk investments that offer as much control over when they can be redeemed for cash.

More information about Savings Bonds

The above US Government website has lots of useful information.  Another good resource is the section devoted to savings bonds at the investor's FAQ, located at http://invest-faq.com/articles/bonds-us-savings.html .  (Note that this site will likely generate "pop-up" adds in your browser.)
 

Please email me at if you have any questions about this, notice any mistakes, or have suggestions for further information.

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Last updated on 11/01/2006