Often flying under the radar these days and almost forgotten about in the 21st century is a really good old friend that I grew up with as a child: the U.S. Savings Bond. Originally developed as encouragement to save (called the “baby bonds”) in 1935 during FDR’s first term during the Great Depression, they eventually evolved into the E bonds that helped finance and pay for World War II back in the 1940’s (War Bonds).
Like many things, it has changed since those days. As a kid in the 1950’s, I recall when I used to buy bond stamps and paste them into my bond folder. Eventually it grew and when held to a maturity date, it was worth $25. I used it then for some huge event in my life, like a new bike or some other big deal!
Years later, the E bonds became the alphabet soup letters of bonds such as F, G, J, K, H, and even HH bonds (which ceased being issued in 2004). Remember those? You would go down to your local bank branch and buy them at “half” face value, hold onto them until they matured, and eventually cashed them in doubling your money. The good old days, right?
While school kids don’t buy savings bonds at school anymore and your bank doesn’t sell them to you either, you can still buy them anytime you like online from the TreasuryDirect.gov website. They offer among others, the well-known EE Bond which was first offered in 1980. It’s a bond with interest added to the bond and paid upon redemption.
Interest rates vary depending issue date, but since May 1, 2005 they all earn a fixed rate of interest. EE bonds can be held and earn interest for up to 30 years.
My Choice: The I Bond with a Guard Against Inflation
The 21st century I Bond which was first issued in 1998 is an accrual-type security with interest added to the bond and paid when the bond is redeemed. I bond interest rates are based upon a combination of a fixed rate of return plus a variable semiannual rate. They grow in value with inflation-indexed earnings for up to 30 years. Series I savings bonds are a great ultralow-risk savings product that earn interest while you own them and will protect you from inflation.
I personally purchased a series of I bonds and here’s a small example of how they have done for me over the years.
True and Factual!
I purchased a $1,000 I bond in September 2001. As of October of 2018, it has a redeemable value of $2,378 and that means it has averaged a growth rate of 5.52% a year since 2001 (all interest and inflation adjustments have been added into the total during that span). Compared to the inflation rate during that same period of 3.8% on average per year, I have outperformed the inflation rate by a whopping 42% by purchasing this bond! Pretty damned good, right?!
Considering that the average inflation rate has been at 3.22% per year over the past 100 years, these bonds are certain to maintain buying power when you finally cash them in. If it’s done in retirement, they may even be done without a tax obligation if you qualify, making them even more valuable!
The Where and What
With an account at TreasuryDirect.gov, you can purchase, manage, and redeem I bonds directly from your web browser.
The current rate on I bonds is 2.52% for bonds issued May-October 2018. This rate applies for the first six months you own the bonds and they are not redeemable for the first 12 months.*
Unlike the fixed rate of other bonds, the rate changes over the life of the I bond. The inflation rate adjustments can and usually do change every six months to give you an inflation hedge!
How do I bonds earn interest? An I bond earns interest monthly from the first day of the month of the issue date. The interest accrues (is added to the bond) for up to 30 years.
*There are minimum purchases on the electronic bonds of $25 and paper bonds of $50 with a maximum purchase (per calendar year) of electronic bonds of $10,000 and paper bonds of $5,000. Note that the paper bonds are available by mail and only with your federal income tax refund.
The Why: Savings Bonds Have Great Benefits
Some things just can’t be overlooked about Savings Bonds like using them for:
- Education Planning
- Tax Planning
- Estate Planning
- Savings Bonds as Gifts
- Retirement Planning
A major highlight is planning for college or any higher education cost.
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. But even aside from the education tax exclusion, there is another way these savings bonds are money savers for you and your children.
Interest income on bonds purchased in a child’s name alone or with a parent as beneficiary (not a co-owner), can be included in the child’s income each year as it accrues, or can be deferred until the bonds are redeemed. In either case, the child will be subject to any federal income tax on the interest rather than the parent.
Parents can file a federal income tax return in the child’s name (the child needs to have a Social Security Number), reporting the total accrued interest on all bonds registered to the child. Full details of this option and its requirements are outlined in IRS Publication 550, “Investment Income and Expenses”.
There is no tax due on bond interest unless the child (or anyone for that matter) has a total income in a single year equal to the threshold amount that requires a return to be filed and no returns need to be filed until that annual income level has been reached in any given year.
A big savings can come when children use the bonds for college or other schooling when over the age of 18, as they pay any taxes due at their own tax rate (and not the parental tax rate as when under the age of 18). The parents’ rate is generally higher since most students have no major income and qualify for low or no tax to be paid at all.
The same tax advantages may apply to a retiree whose income may be reduced significantly after retirement and thus the tax implication will be low or eliminated as well.
The tax liability on bonds is due when redeemed for the current year’s federal income tax. Make sure you keep complete records.
Buying Bonds Through Your Paycheck?
You can set up a Payroll Savings Plan to purchase electronic savings bonds at TreasuryDirect.gov. The Payroll Savings Plan feature allows individual primary account owners to make recurring purchases of electronic Series EE and Series I Savings Bonds, funded by a payroll allotment/direct deposit. Simply set up your Payroll Savings Plan and schedule a regular payroll allotment/direct deposit with your employer and your payroll office will send the funds to your TreasuryDirect.gov account. It’s really easy.
Just having savings bonds is not going to make you a wealthy person. If it did, everyone would be on it like white on rice. In my days working at major banks, people tended to ignore their value and had to be “sold” on their virtue. It hasn’t really changed since I retired from telling clients about them. But savings bonds, particularly series I savings bonds, will beat every type of savings account currently available right now.
It’s just plain smart to use them for a retirement plan or for use in an education plan when using the tax exclusion portion benefit. It costs nothing to buy, hold, or manage and is as safe as safe can be, FDIC insured. The biggest advantage is that I bonds will never lose money against the inflation rate if you don’t prematurely cash them in when you decide you need them. All the details can be learned on the site, so get to it!
Do you own any saving bonds these days? Have you ever? Are you familiar with series I savings bonds and their inflation hedge protection? Compare these bonds to the current so called “great” CD rates and saving account rates that banks are currently offering. You will be very surprised when you do at bonds’ favorable advantages!