Many have memories of receiving a savings bond from Grandma and keeping it locked away for decades, with little understanding of exactly how much they earn or how they work.
There are two types of savings bonds:
EE Series – the ones you are probably familiar with:
I Series – Savings bonds whose interest rate changes based on inflation. These are a new for most people.
Let’s take a closer look at each of these bonds:
Up until a few years ago most savings bonds were issued in paper form, like you see above. Every kid grew up with a few of these stocked away. However now, the Treasury has ruined future generations by doing away with the paper bonds altogether. That’s right, today the only way to buy bonds is to buy EE series savings bonds is solely in electronic format.
With these old paper bonds, you purchased the bond for half of the face value. Meaning the $1000 bond seen above was purchased for $500, and that $500 accrued a fixed rate of interest year after year for up to 30 years. Eventually it would become worth more than $1000.
But times have changed. Today’s EE bond is a different animal than what your grandma gave you. Today’s bonds exist only in electronic format. (I guess you get to teach your grand-kids about saving by giving them a printed out confirmation of a savings bond purchase?)
EE bonds earn interest for 30 years. Savings bonds purchased since May 2005 have a fixed interest rate for 20 years, then can be adjusted for the final 10 years. This adjustment after 10 years is based on then current interest rates.
The bonds cannot be sold for at least 1 year, and if they are sold in less than 5 years you lose the last 3 months’ worth of interest as a penalty.
Individuals are limited to $10,000 of EE savings bond purchases per year, and you can buy any amount to the penny as long as it is over $25. (For example, a $50.23 bond)
Upon selling your savings bond, you do have to pay federal taxes on the interest you earned, but you are not required to pay state or local taxes. However, if the bonds are used for “Qualified education expenses” you do not have to pay tax on the interest. But be sure to read all the fine print on that benefit here: http://www.treasurydirect.gov/indiv/planning/plan_education.htm
Because of today’s dreadfully low interest rates, the interest rate earned on EE bonds is next to nothing. Today, a savings bond purchased would earn 0.20% for 20 years, meaning $1000 invested today would be worth a whopping $1040 after 20 years. Today EE savings bonds have no use, as most money market accounts earn twice that. However, investors who purchased EE savings bonds in 2005 are earning a “handsome” 3.5%, which is actually a pretty good deal for today.
Rates will change in the future, check out Treasury Direct’s EE bond page for the current interest rate:
Curious how much your old savings bonds are worth? Check out Treasury Direct Savings Bond calculator here:
So how should you use EE savings bonds for your savings goals?
Keep them in mind for when interest rates get back to normal. Just remember that you are locking in a fixed rate for 20 years. Today, money should be put elsewhere.
I Series, commonly known as “I Bonds”, are quite different. I bonds earn interest in 2 ways:
A Fixed Rate – This stays the same for the life of the bond and is known at the time of purchase.
A Variable (Inflation) Rate – This is changed every 6 months based on the government’s inflation numbers.
For example, I bonds purchased today have an interest rate of 1.18%. How does the Treasury come up with 1.18%?
Like EE bonds, I bonds are purchased at face value (a $50 bond costs $50) and earn interest for 30 years. I bonds cannot be sold for 1 year minimum and if sold before 5 years you give up the most recent 3 months of interest as a penalty.
Unlike EE savings bonds, I bonds can be purchased in paper format ONLY in $50 denominations as your tax refund. They can also be purchased online at treasury direct in any amount to the penny as long as it is above $25.
I bonds have the same tax rules as EE bonds. You do have to pay federal taxes on the interest you earn, but you are not required to pay state or local taxes on any interest earned. However, if the bonds are used for “Qualified education expenses” you do not have to pay tax on the interest. But be sure to read all the fine print on that benefit here: http://www.treasurydirect.gov/indiv/planning/plan_education.htm
You are also allowed $10,000 in electronic I bonds per year, along with $5,000 in paper form.
The latest I bond rates are on Treasury Direct’s website here: http://treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm
So how should you use I bonds?
Because of the variable interest rate, your chance for any kind of real return is a little higher. In times of normal interest rates, these make very handy investments as you get a certain minimum fixed interest rate, in addition to a variable rate component. For example, investors who purchased I bonds in the late 90s are still earning a fixed 3.4% in addition to the inflation component 1.18% annually (for a total of 4.58%) compared to an investor who buys an I bond today for a fixed rate of 0% and an inflation component of 1.18% annually, (for a total of 1.18%).
Personally, I buy a small amount of I bonds every 2 weeks and consider it as part of my emergency fund (Though keep in mind you can’t sell them for at least 12 months…so don’t have an emergency fund made up of just I bonds!) and figure that if I never have to sell them they will help pay for a kid’s college tuition in the future.
For a comparison between I Bonds and EE bonds, Treasury Direct has a nice comparison: