Bond Investing For Dummies Cheat Sheet
What Are the Best Short-Term, High-Quality Bond Funds?
How Do Annuities Work?

Savings Bonds as Gifts or Small Investments

Until recently, U.S. savings bonds had been popular as gifts in part because they were sold as nicely designed certificates. On January 1, 2012, however, they became electronic entities, just like other Treasury securities.

It remains to be seen if they will still be desirable as gifts in this less attractive, less personal format. You may now buy your electronic savings bonds straight from the official Treasury website: TreasuryDirect. If your purchase is intended as a gift, the website allows you to print a gift certificate, which may be presented in lieu of the once keepsake-quality, elaborately designed bond.

Of course, savings bonds can be more than just gifts: You can buy one for yourself. People do so, despite their awfully low interest rates of late.

Savings bonds start as low as $25. Beyond that, you don’t need to pick a specific denomination. If you wish to invest, say, $43.45, go for it, or if you want to invest $312.56, that’s fine too. Any amount over $25 but under $10,000 (per individual, per year) is accepted.

Note that these “denomination-free” bonds are available only through the Treasury website and available only for savings bonds. The other Treasury securities (bills, notes, or bonds) can also be purchased through the website, and elsewhere, but only in specific increments.

Aside from the ability to invest a small amount, savings bonds are also unique among Treasury debt securities in that they are strictly non-marketable. When you buy a U.S. savings bond, you either put your own name and Social Security number on the bond or the name and Social Security number of the giftee.

The only person entitled to receive interest is the one whose name appears on the bond. The bond itself (just like an airline ticket) cannot be sold to another buyer — in stark contrast to Treasury bills and bonds that can, and often do, pass hands more often than poker chips.

Through history, there have been various kinds of savings bonds. At present, the Treasury produces only two: EE Series bonds and I bonds. Some others you may have stored away in your dresser drawers may include E Series bonds and HH bonds. Each has its own characteristics.

EE bonds

EE bonds (from 2001 to 2011, many were called “Patriot Bonds”) are the most traditional kind of savings bond. Series EE bonds carry a face value of twice their purchase price. They are accrual bonds, which means they earn interest as the years roll on even though you aren’t seeing any cash.

You can pay taxes on that interest as it accrues, but in most cases it makes more sense to defer paying the taxes until you decide to redeem the bond. Uncle Sam allows you to do that.

Series EE bonds issued prior to May 2005 pay various rates of interest depending on the date of the bond. Most of these rates are based on fairly complicated formulas and fluctuate over time. If you own a pre-May 2005 savings bond and you aren’t sure what kind of interest the bond is paying, the best thing to do is to look it up on TreasuryDirect. EE bonds issued during May 2005 or afterward pay a fixed interest rate.

EE bonds are nonredeemable for the first year you own them, and if you hold them for fewer than five years, you surrender three months of interest. Any individual can buy up to $10,000 in EE savings bonds a year. Interest compounds twice a year for 30 years.

If you use your savings bonds to fund an education, the interest may be tax-free.

Historically, savings bonds have paid a rate of interest that has barely kept up with inflation. Therefore, you don’t want to make them a major part of your investment scheme. If you already have savings bonds, you may want to consider swapping them for a higher yielding investment.

If you wish to keep them, consider opening an account at TreasuryDirect and turning your paper bonds into electronic securities. That way, you won’t need to worry about them getting lost or destroyed.

I bonds

The I Series bonds offer a fixed rate of return plus an adjustment for rising prices. Every May 1 and November 1, the Treasury announces both the fixed rate for all new I bonds and the inflation adjustment for all new and existing I bonds.

After you buy an I bond, the fixed rate is yours for the life of the bond (since the current rate is zero, you probably aren’t breaking out the champagne right now). The inflation rate adjusts every six months. You collect all your interest only after cashing in the bond. (That is called accrual interest.)

The rules and parameters for I bonds are pretty much the same as they are for EEs: You have to hold them a year, and if you sell within five years, you pay a penalty. There’s a limit to how many I bonds you can invest in — $10,000 a year, per person. And in certain circumstances, the proceeds may become tax-free if used for education expenses.

Because the rate of inflation can vary dramatically from one six-month period to another, at times I bonds make for fabulous short-term investments. In November 2005, for example, following a spike in the price of oil after Hurricane Katrina, the official inflation rate shot up, and I bonds were paying a very impressive 6.73 percent.

At that point, anyone who had cash to invest might want to consider them very seriously. But, by the following May, with inflation having cooled, the yield on I bonds dropped rather precipitously to 2.43 percent. They were no longer such a hot investment — you could have done much better with a bank CD.

If you plan to hold I bonds as a long-term investment — longer than a year or two — you should be more concerned with the fixed rate (which will be in effect throughout the life of the bond) than the inflation adjustment (which will vary). Remember that if you cash out before five years, you’ll pay a penalty of three months’ interest.

blog comments powered by Disqus
How Are Callable Bonds Risky?
What Is the Total Return of a Bond Investment?
Bond ETFs: Tapping the Treasurys
What Is Standard Deviation In Bond Investing?
Will Municipal Bonds Default?
Advertisement

Inside Dummies.com