I have used other posts to describe several alternatives for the saver. In one, I focused on commercial banks, in another on savings banks and credit unions, and a third post on investment clubs. Here I offer yet another option: U.S. government savings bonds. This post also includes a note on on-line banking.
U.S. Government Savings Bonds
Savings bonds are about as safe an investment as exists. They guarantee repayment plus interest at a set future date. You can also redeem these bonds, including the accrued interest, before the stated maturity date. Called Series EE bonds, they pay a rate that the Treasury sets each May and November. Once you have bought the bond, that rate is guaranteed for its stated term — up to 30 years on some bonds.
Savings bonds are sold at a discount.” This does not mean a special low price, but rather that the bond sells at a substantially lower price than the repayment amount to account for all the interest it will accrue over its term to maturity. Unlike savings accounts at banks or credit unions, which pay interest out at regular intervals over time, the earnings on savings bonds come in one lump sum when the bond matures. For example, you may buy a $50 bond for only $25. The $50 the Treasury gives you at maturity repays you your original $25 plus all the interest earned on it during the time that the Treasury held the money. The Treasury sells bonds of various maturities in denominations of $50, $100, $200, $500, and $1,000.
At one time, you could buy paper savings bonds at banks for no fee. You got a piece of heavy, elaborately printed paper indicating the amount due to you at maturity. The bank also registered you as a holder with the U.S. Treasury. But now, for the sake of economy and security, the Treasury sells EE savings bonds directly to the purchaser though its “TreasuryDirect” program: the entire transaction is electronic. Holders of paper bonds can transfer them to their digital counterpart free through the Treasury’s “SmartExchange” program. You can learn more about these programs, including the prevailing rate the government pays on savings bonds, on the Treasury’s website, www.treasury.gov. There you can also learn about the Treasury’s inflation-indexed savings bonds, called I-bonds. Unlike EE-bonds, these come with a guarantee they will keep up with inflation.
Here are some of the tradeoffs between savings bonds and the other savings options we have already discussed:
- The rate of interest is similar to that of a savings account, either at a commercial bank, savings banks, or credit union. If anything, EE-savings bonds offer a marginally lower rate because they are so safe.
- The fixed interest rate to maturity can cut two ways. On the positive side, you know exactly what you are getting. Should market rates fall, you will continue to earn at the original stated rate. With other accounts, the rate goes up and down — “floats” in financial jargon — depending on variations in Federal Reserve policy and financial markets. On the negative side, the savings bond will only pay you the stated interest rate even if interest rates rise, whereas the rates paid by a savings account will eventually float up to where market interest rates are.
- Liquidity is limited. You can get back your money on EE-bonds or I-bonds before maturity, including accrued interest, but doing so is a lot less convenient than having an account at a savings bank, credit union, or commercial bank, especially one that has a network of ATMs.
- Government savings bonds have tax advantages that savings accounts don’t. The interest earnings on them are free of state and local income taxes. You must pay federal income tax on the income from the bonds, but you can elect to defer the tax bill until the bonds mature. Government savings bonds also have tax advantages if you use them to pay for a child’s education. If you put the bonds in the child’s name, set to mature when the money will be needed for college, the interest on the bonds is taxed at the student’s presumably lower income tax rate. (More on these and other tax-advantaged investments in a later post.)
A Note on Online Banking
Recent years have seen the appearance of online banks. They offer banking services, including saving accounts, solely through the Internet — they have no physical presence. Theoretically, their lower overhead costs should allow them to pay higher interest rates than brick-and-mortar establishments, but recent (admittedly unscientific) surveys reveal little difference in those rates. Although some people might feel uneasy about entrusting their savings to an entity with no physical presence, the record thus far shows no greater problem with online arrangements than with others. Keep in mind that most banking, even in the oldest of institutions, is now more electronic than physical. The list of firms offering on-line arrangements is growing, including some that are large and well established. Make sure that any online bank you are considering has the same insurance – especially Federal Deposit Insurance — and safety checks that traditional firms do.