Don't Overlook Series I Savings Bonds

If you are a low-income investor (perhaps a recent college graduate) saving for a financial goal that has a time horizon of five years or greater, such as a down payment on a home or higher education expenses; or if you are just looking for a good, conservative place to park your cash, don't overlook Series I savings bonds.

Both Series I bonds and Series EE bonds are Treasury securities with 30-year maturities: they stop paying interest after 30 years. Series EE and I bonds are sold in increments of $50, $75, $100, $200, $500, $1,000, and $5,000. Series I savings bonds, unlike their counterparts, are sold at face value ($50 dollars for a $50 dollar Series I savings bond; EE bonds are sold at half their face value), on TreasuryDirect.gov.

Formerly, the bonds were offered solely as paper securities, but in 2003, the Treasury Department decided to end the paper offering, citing administrative cost considerations. Further, last year, the Treasury Department announced a reduction of the amount of savings bonds an individual investor could buy per year from $30,000 to $5,000 effective January 1, 2008. However, the announcement came with a somewhat confusing caveat: investors could buy $5,000 dollars worth of electronic I bonds, $5,000 dollars worth of paper I bonds, $5,000 dollars worth of electronic EE bonds, and $5,000 dollars worth of paper EE bonds. Paper bonds can still be purchased via some employers by payroll deduction.

What makes Series I savings bonds appealing is that they are guaranteed to beat inflation. The interest rate I bonds pay is based on two rates: a fixed rate and an inflation rate. The fixed rate is the rate of interest you will receive over the course of the life of the bond. Each May and each November, a new fixed rate is announced. Any I bonds bought after May but before November will enjoy May's fixed rate for the life of the bond.

The second rate is the inflation rate. Every six months, each May and November, a new inflation rate is announced, which is a function of the country's actual semiannual inflation rate. Your bond will enjoy the new inflation rate plus the fixed rate for the following six months. If in November, the fixed rate is 1%, and the inflation rate is 4%, you will earn 5% on the bond for the next six months. The current rate is 5.64% until May, when the inflation rate resets.

You don't have to hold these bonds 30 years before you cash them in, but they cannot be redeemed during the first 12 months of ownership. Bonds can be cashed in after a year, but if you do so before you have owned them for five years, you will forfeit three months worth of interest payments (making them somewhat similar to CDs). They can be redeemed at most banks or online at TreasuryDirect.

A cursory review of CD rates at BankRate.com, a website that tracks, among other items, the interest rates associated with various banking products across the country, reveals that interest yields for one and five year CDs across the country are quite low. And for the low-income saver, the average $500 dollar minimum require to open a CD accounts, may be difficult to come up with. Purchasing savings bonds in small increments through payroll deduction may be more manageable.

With I bonds, your principal, backed by the U.S. government, is secure, and you receive a competitive interest rate. You can defer interest accrued on your savings bonds each year until you cash them in or pay taxes on the interest each year - your choice. You also may be able to use your savings bonds to pay for higher education expenses, such as graduate school, without paying taxes on the accrued interest. Visit the IRS website for more information regarding this great benefit.

With this said, Series EE bonds are actually a pretty bad place to park your money. EE bonds pay just a fixed rate of interest for the life of the bond. Every May and November new rates are announced, but the current rate is just 1.3%. Considering that your money will be locked up for at least a year, and that you will always earn just 1.3% on securities bought before May, you'd be better off with a savings account.

While I bonds may be a good fit for some of your savings goals, this is not a good option for retirement savings. Especially if you are in your twenties or thirties, you need to make investments that return higher interest rates over the long-term in order to secure a comfortable retirement.

Sources

CD Investment Rate Results, Bankrate.com

Jonathan Fuerbringer, THE MARKETS: BONDS; Treasury Is Moving to Make All Savings Bond Sales Online, The New York Times

Dr. Don Taylor, PhD, CFA, What's behind new savings bond limit?, Bankrate.com

Treasury Department, Individual - I Savings Bonds Rates and Terms, TreasuryDirect

Treasury Department, Individual - EE/E Savings Bonds, TreasuryDirect

Treasury Department, Individual - I Savings Bonds, TreasuryDirect

Treasury Department, Individual - I and EE Savings Bond Comparison, TreasuryDirect