I can understand why people aren’t buying Treasury Inflation-Protected Securities (TIPS). As described Friday, they’re new; there aren’t many choices on holding periods; buying and selling them require brokerage fees unless you can wait for the infrequent Treasury auctions and hold to redemption; and the inflation adjustment is taxed as income each year even though you don’t actually get it until you sell. Also, you can only buy them in $1,000 increments.
So what if we add about 50 more years of familiarity; let you choose any holding period you want between 5 and 30 years (and you don’t have to decide now); eliminate any need for brokerage or any other fees; not tax either the interest or inflation adjustment until you redeem the bonds — and let you buy them in $50 increments? Will that make you happy?
Welcome to the new world of U.S. Savings Bonds. In 1998, one year after introducing TIPS, the federal government introduced a new form of Savings Bond called the Series I (for inflation, not the Roman numeral) Bond. If you buy one today, you are guaranteed an annual return of 7.49% for the first six months, with the rate adjusted every six months to the sum of 3.6% plus the rate of inflation. And you can buy one online with a VISA or MasterCard card within the next 10 minutes, even allowing 5 minutes to finish this column.
(There’s no surcharge for using a credit card, so, if you have that kind of card, you get the frequent flier miles — equivalent to an extra 2% tax-free return!)
U.S. Savings Bonds started as war bonds paying miserable returns. Patriotism made up the difference — that, and the fact that small savers had no alternatives. There were no money market funds, and the interest on savings accounts was fixed by law at a ceiling that ranged between 1.5% and 3.5% in the Thirties, Forties and Fifties. (Christmas Clubs paid 0%.) Today, we’re not at war and alternatives abound, so the Treasury has had to be more competitive. And it has been. The 7.49% yield on Series I Bonds should be of interest to just about any small saver. A few key facts:
- Series I Bonds are dated the 1st of the month of purchase, and earn interest from that date (so buying late in the month makes sense — you get three or four weeks’ free ride).
- They can’t be redeemed until the bonds are six months old.
- If they are redeemed before they are 5 years old, the last 3 months of interest is lost. But at today’s rates, holding them for just 2 years and then redeeming them will probably outperform most 2-year CDs even after losing the last 3 months’ interest (especially if you pay state income taxes, since Savings Bonds are exempt from these).
- They stop earning interest after 30 years.
- The interest is accrued monthly (compounded semi-annually), and you can, if you wish, elect to pay taxes on the growth without waiting for redemption. That could make sense for bonds in the name of a child in a low tax bracket. Little or no tax would be due each year; and, by satisfying the tax man on a pay-as-you-go basis, no tax would be due at redemption.
- These are such a terrific deal that the government limits calendar year purchases to $30,000 for each Social Security number. If you’ve got much more to invest, you might want to take another look at TIPS, which are currently promising over 4% plus inflation (but with that rotten tax to pay each year on the inflation adjustment, even though you don’t receive it).
A small additional advantage for seniors:
Seniors are required to pay taxes on up to 85% of their Social Security benefits if their “provisional income” exceeds certain amounts. Many have learned to their annoyance that tax-exempt municipal bond interest is included in calculating provisional income, and can thus bump up the taxable portion of the Social Security benefit. Savings Bond interest, however, is NOT included in provisional income until you actually redeem the bonds (unless you elected the pay-as-you-go approach mentioned above).
A possible advantage for tuition payers:
Normally, the tax on Savings Bond interest is deferred as it accrues, taxable in full when you redeem the bonds. But if someone at least 24 years of age buys a Savings Bond and then, years later, spends the proceeds upon redemption for college tuition, fees, and books (personally or for a dependent), the interest can be entirely exempt from taxation. Say you’ve got a 13-year-old and are frightened by the short-term prospects for the stock market. It is worth considering that a tax-free 7% might be pretty hard to beat (of course, if inflation drops, the return on these bonds will drop, too; but the converse is also true). Unfortunately, the exemption is phased out for higher income taxpayers, and there are several confusing restrictions, so you’d better check the rules carefully if you’re really counting on this one. Note that you CANNOT hold the bonds in the name of the child and get this benefit (the owner, remember, must be at least 24 on the date of purchase). By the way, if you redeem savings bonds and put the proceeds into a 529 qualified state tuition plan, that is considered a qualified higher education cost itself and will exempt the interest on the bonds from taxation if the other requirements are satisfied.
A final word or two:
TIPS and Series I Bonds are attractive for small savers. They’re totally safe and protect against inflation. TIPS would be good for a retirement account. Otherwise, Series I Bonds probably make more sense. Large, high-tax-bracket investors might prefer municipal bonds — after all, munis are tax-free, not just tax-deferred. Then again, they don’t currently pay as much as TIPS or Series I Bonds, and if inflation rises, muni-owners will fare worse than TIPS- or Series I Bond-owners. (If inflation falls, muni-owners will fare better.)
We started this discussion looking for a safe place for 5-year money. For many savers, Series I Bonds fill the bill.
And you’ve still got 5 minutes left to buy some. (You can buy as little as $50 or up to $500 online at one time.) Check out savingsbonds.gov. You can stop at any time before hitting the PAY button. Just find out how easy it is. And see if you can figure out who those people are on the different bonds. That’s Martin Luther King, Jr., on the $100, but who are the others?
Quote of the Day
In 1800, 75% of [an American's] working man's expenditures went for food alone. By 1850, that had dropped to 50%. Today it is a little more than 11%.~The Wall Street Journal, September 20, 1996
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