Searching for yield? Think savings bonds

September 26, 2011

Yields on certificates of deposit, Treasury bonds, and other interest-bearing securities have gotten so low that a mundane investment usually associated with birthdays and bar mitzvahs looks enticing by comparison.

But if you’re thinking of buying Series I savings bonds you might want to do it soon, since new regulations set to take effect next year will limit purchase amounts and make them harder for many people to buy.

Thanks to an uptick in prices for gas, food and other consumer goods, the bonds — which peg their yields to inflation — carry an annualized yield of 4.6 percent. By comparison, the average rate on a one-year CD is around .75 percent.

The variable rate, which applies to I-Bonds issued from May through October, consists of two blended components: a fixed rate that stays the same over the entire 30-year life of the bond and a rate pegged to the Consumer Price Index for All Urban Consumers (CPI-U), which changes twice a year.

The rate will re-set on Nov. 1 and based on recent inflation numbers would come in at around 3.3 percent according to Tom Adams, author of the book Savings Bond Advisor. While that’s lower than the current rate, which lasts for six months on bonds purchased through October, it’s still better than most other alternatives out there.

“People should look at I-Bonds as inflation insurance,” he says. “And right now their yields are quite attractive, especially compared to other types of interest-bearing investments.”

One drawback is you have to hold the bonds for at least a year, and you’ll forfeit three months of interest if you cash them in before five years. But even after the interest penalty, I-Bonds are still a better deal than a low-yielding CD.

Adams figures that someone who buys an I-Bond now, holds it through next September, and cashes it in at the end of that month would earn a little more than three percent over the course of the year — after taking the penalty into account. “That’s a better deal, with complete safety, than you can get right now with a one-year CD,” he observes.

The bonds have a number of other attractive features.

  • Their value can never go down, even in a deflationary environment.
  • Interest is added to the bond’s value rather than distributed. When they’re cashed in, the accrued interest is taxed at regular income rates. That makes it possible to put off paying taxes until retirement or another time when bond owners are in a lower tax bracket.
  • Because they are Treasury securities, interest is subject to federal, but not state or local taxes. Depending on your income, you may not have to pay tax on interest at all if the bonds are used for qualified higher education expenses.
  • You can buy one for as little as $25.

The biggest downside is new government rules scheduled to take effect in January that will both limit purchases and make it harder for many people to buy both the I-Bonds and fixed-rate Series EE savings bonds.

Three years ago, the Treasury Department reduced the maximum annual purchase amount per Social Security number from $30,000 to $5,000, which applies separately to each type of savings bond and to paper and electronic purchases. That means each spouse of a married couple can now purchase $10,000 worth of I-Bonds a year, ($5,000 electronically and $5,000 paper) for a total of $20,000 per couple. Single individuals can buy $10,000 worth of the bonds annually.

The maximum purchase limit will be effectively halved in January, when paper savings bonds will no longer be available through banks and credit unions (though you can still redeem old ones). Instead, all purchases will have to go through TreasuryDirect, the government website. The only way to buy paper I-Bonds will be through a refund on your tax return.

Buying the bonds online can be something of a hassle in the beginning because it requires opening a TreasuryDirect account, waiting up to two weeks to get an access card, and then going back online to make the purchase. If you’re giving the bonds as a gift, the recipient must also have a TreasuryDirect account.

While the government says the move will save some $70 million over five years, it will also fence out millions of people, many of them lower-income individuals who invest in small increments, who don’t have an Internet connection or bank account. These issues — along with the appeal of an artistically designed piece of paper you can touch, smell and stash in a safe deposit box next to old jewelry — may help explain why only 11 percent of savings bonds transactions are conducted online, according to the Bureau of Public Debt.

Removing paper bonds from the places people have bought them most for over 75 years will probably be more effective in discouraging purchases than moving them to the Internet. With the pressing need for people to save, this is a bad time to be putting the kibosh on what has emerged as one of the more attractive forms of U.S. debt.

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