Ah Savings Bonds, most any investment book you can find will have a portion on the safest of bond investment choices and typically they are excruciating. Hopefully I can convey the same form of information in a fashion that is more approaching a stubbed toe rather than a root canal. Be sure to check out our introduction to bonds if you aren’t sure what a bond really is. All of the bond types we’ll cover today are what are called Treasury issues (you probably know them as savings bonds) which means they are backed by the full faith and credit of the U.S. government, so obviously you should have nothing to worry about (insert sarcasm here). The cherry on top of these investments is that the interest income generated by these savings bonds is exempt from local and state taxes. Sweet.
U.S. Savings Bonds
There are two types of savings bonds offered by the U.S. Treasury and they are I bonds and EE Bonds. Once you purchase one you’ll have to hold it for over a year and at that point you could cash them in with no loss in your principal amount. Let’s start with EE Bonds because with two letters it has to be a better choice.
EE Bonds have a fixed rate of return that is determined by the U.S. Treasury using a method that apparently involves magical pixie horses or some form of aquatic ceremony. Honestly the formula is hidden so you’ll get what you get. These bad boys will continue to get the same rate for 20 years after your purchase. At the absolute minimum you’ll get 3.526% if… you hold them for 20 years. As of this writing the current rate is 1.2%. Yes I know this is painful, online savings account anyone? You can purchase them in sizes of $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000. When you buy one it’s at half of it’s face value. So when you purchase a $50 savings bond it’s actually only $25. The assumption is that in the time that you purchase the savings bond and then flash forward 20 years it will have made enough interest to be worth twice the original amount. If it does not the Treasury will make a one-time adjustment to bring the bond up to it’s full face value.
I Bond do take you investor for the rest of your life to earn very little interest above the inflation rate till death do us part. I Bonds (I for Inflation) are another form of Treasury provided bond with the sole purpose to provide a safe investment that will protect you the investor from inflation. No more no less. These suckers have two rates associated with them. The rate you will see is the fixed rate sometimes referred to as the real rate that will be added over and above inflation. As of this writing it’s an incredibly lame 0.3%. This rate sticks with you for the life of the savings bond. The second rate is calculated twice a year and is based on the rate of inflation for the previous 6 months. Add those two together and you get your overall return for the next 6 months. For December we had an inflation rate of 2.72% so your overall rate for that time period would be a paltry 3.02%. But of course your money would be safe.
When you purchase an I Bond it will be the face value of the bond. You can purchase in increments of $50, $75, $100, $200, $500, $1,000 and $5,000.
A Bit about Taxes
One of the better benefits of the Savings Bond is that the interest money is tax deferred until you redeem them or 30 years whichever comes first. This means that you can hold on to them in a non-retirement account and enjoy the benefits of not being taxed on your $3.48 interest that you’ve earned.
Where to Buy Savings Bonds
You can buy them online at TreasuryDirect or from most banks and credit unions.
TIPS for Bond Investors
What TIPS? No it’s called TIPS! Right, you’re going to provide bond TIPS so get on with it. Treasury Inflation-Protected Securities. Yep it’s a government program alright. The main difference between TIPS and an I Savings Bond is that they are a marketable security meaning you can buy and sell them in the securities market whereas with an I Savings Bond you turn it back in to the government for the return. Also TIPS guaranteed rates are usually higher than I Bond fixed rates although that can easily change. TIPS pay out interest twice a year on the rate above inflation. You’ll get the rest of that inflation money at the maturity date.
A Tiny Itty Bitty Tax Detail
If you have purchased TIPS outside of your tax deferred retirement account you’ll pay taxes annually on the inflation matched income from the TIPS even though you aren’t going to actually receive that income until it matures. Surprise! It’s known as phantom income. You’ll also get taxed on the fixed rate income that you do receive. Neat.
Where to Purchase?
Again like the other savings bonds you can purchase them from TreasuryDirect which is the primary market and also through secondary markets which we’ll talk about later in this series.
This is a good question, these are extremely conservative investments and as such are geared towards the low to no risk investor although they might be a good hedge in your own portfolio. Something to consider when working out your investment strategy. Come on back tomorrow where we’ll talk about different ways to invest in bonds. And if you missed it head on over and check out yesterday’s introduction where we talk about What is a Bond? You can also do some workups on various bond returns using the savings bond wizard, something you might want to fiddle with to get a good idea on what you’ll be earning.
Photo Courtesy peteSwede