Aip Headlines: Savvy Consumer: U.s Savings Bonds Have Become Attractive Investments

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By: Teresa McUsic

http://www.star-telegram.com/2011/05/12/3071930/savvy-consumer-us-savings-bonds.html

Here’s one good thing to come out of rising prices: Savings bonds rates moved up this month.
Series I Savings Bonds bought from May through October earn interest at an annual rate of 4.6 percent, according to the Bureau of the Public Debt. That attractive rate comes with some qualifiers, but given today’s puny rates on other savings alternatives, like certificates of deposit, the bonds are worth a closer look.
The Series I bond is a combination of a fixed rate and a variable rate based on inflation (hence the “I” in the name), as measured by the Consumer Price Index for all Urban Consumers. The bonds are earning a zero percent fixed rate of return but a 2.3 percent six-month variable rate.
That means investors who buy a Series I bond from May through October will realize a yield of at least 2.3 percent in those six months. If on Nov. 1, when both rates reset, the fixed rate is still zero and the inflation-indexed rate is still 2.3 percent, the bonds would pay a combined 4.6 percent for ...
... the 12-month period.
But even if inflation slows, the Series I bond still beats bank CDs, said Ken Tumin, an Austin-based financial writer and author of DepositAccounts.com, a popular blog that lists deposit rates from banks and credit unions across the country. “Currently, the best one-year bank CD yield is only 1.4 percent,” Tumin said.
Rising gasoline and food prices have a major impact on the CPI, which had a six-month increase of 2.3 percent, Tumin said.
“The previous I bond six-month rate was just 0.37 percent,” he said. “It actually went negative in 2009 after the 2008 financial crisis.”
He figures an investor buying a Series I bond this month won’t do worse than 2.3 percent for the following 12 months and will likely do better. Here’s the math:
You buy the bond in May and redeem it a year later. The first six months you earn 2.3 percent. The second six months, assume the fixed rate remains at zero (where it has been the past two six-month periods) and the inflation-based rate falls to zero. Under this scenario, you’d get 2.3 percent for the year. (There is a penalty of the most recent three months’ interest when redeeming a Series I bond within five years. But under this scenario, since interest was zero, the penalty would also be zero.)
Tumin doesn’t think the next six-month rate will be zero.
“Most likely that November rate will be around 2 percent,” Tumin said.
Smart Money agrees with Tumin. “Right now, compared to other types of fixed-income investments they’re looking pretty good, especially once you factor in their tax advantages,” Bill Bischoff wrote for the magazine this week.
You have to pay taxes on interest earned on a Series I bond, but not until you redeem it, which can be as much as 30 years after purchase. And there’s a nice tax break: Interest earned is tax-free if you use the money for college tuition or fees for yourself, your spouse or a dependent. (This exception phased out last year for filers with modified adjusted gross incomes above $85,100 for a single filer or $135,100 filing jointly or a qualified widow or widower.)
There are also some downsides.
There is a penalty for redeeming the bond within the first five years. The penalty is equal to interest earned in the most recent three months.
And you can only purchase a maximum of $10,000 a year — $5,000 worth of traditional paper bonds and another $5,000 worth of electronic bonds. However, that limit only applies to individuals, so more can be purchased in the names of spouses, children or grandchildren.
On the plus side, though, Series I bonds are backed by the federal government and are as safe as FDIC-insured CDs.
“For small investors looking for a safe, short-term return, Series I bonds are again a good deal,” Tumin said. “They’re also good for someone who wants to keep a portion of their portfolio in something safe and conservative.”
Smart Money’s Bischoff also likes Series EE Savings Bonds. If purchased by Oct. 31, they earn a fixed annual interest rate of 1.1 percent for up to 30 years.
But Series EE bonds have a special caveat: If you hold them for 20 years, the government will pay enough extra interest to guarantee you double your money. That equals an annual interest rate of 3.53 percent, Bischoff writes. EE bonds have the same maximum purchase limits and are taxed the same way as Series I bonds.
Teresa McUsic’s column appears Fridays.