EE vs. I Bonds: Which Are Better? U.S. Savings Bonds Can Be an Integral Part of an Investment Strategy

EXECUTIVE SUMMARY * CPAs WHO PROVIDE FINANCIAL PLANNING SERVICES need to weigh the similarities and differences between U.S. Treasury series bonds and bonds to help clients make savings bonds a part of their investment strategy. * SERIES AND SERIES BONDS HAVE interest rates that vary over the life of the bonds. No interest is paid on either or bonds until they are redeemed. * PAPER SERIES BONDS ARE SOLD AT 50% of face value, with an individual maximum purchase of $60,000 face value per year. Electronic bonds are sold at face value with an annual purchase limit of $30,000. Series bonds are sold at face value; individuals can purchase a maximum of $60,000 face value per year ($30,000 paper bonds and $30,000 electronic bonds). * FOR FEDERAL INCOME TAX PURPOSES, both series and series bondholders may recognize the interest income on an accrual or cash basis. * BOTH SERIES AND SERIES BONDS issued on or after February 1, 2003, have a 12-month minimum holding period. A penalty equal to the last three months of accumulated interest applies to bonds redeemed within five years of their issue date. * BONDS ARE GUARANTEED TO REACH THEIR MATURITY at face value within 20 years, which means the minimum effective pretax annual rate of return is slightly more than 3.5% with semiannual compounding. There is no such guarantee for bonds. * IF SERIES OR SERIES BONDS ARE CASHED IN to pay for qualifying higher-education costs, taxpayers can exclude the accumulated interest from their income. During these days of stock market uncertainty, many investors are looking for safer, more conservative investments. Market returns often are subject to a great deal of volatility, and the return on most bonds is heavily influenced by changes in interest rates. Interest rates are currently low but have begun to rise. The rate of inflation also has been low. A return of inflation would force interest rates upward and decrease the market value of a bond investment, resulting in a loss of capital for those forced to sell prematurely. For investors who are concerned about a possible loss of capital or who are seeking safer and more secure returns, there are some other options available. CPAs who provide financial planning services should know about a relatively new investment alternative offered by the U.S. Treasury Department--series savings bonds. The Treasury Department began issuing I bonds on September 1, 1998. They are similar to the better-known series EE bonds in many ways, but they differ in several important aspects. This article compares and contrasts the characteristics of bonds with bonds, then compares their respective performances from the date bonds were initially issued through May 1, 2004, the latest announced interest date. Understanding the similarities of and differences between these two options, and bonds, will enable CPAs to better help clients who want to make savings bonds a part of their overall investment strategy. SERIES BONDS The federal government began issuing paper bonds in July 1980. Paper bonds are issued at a discount of 50% of their face value. The government offers them in denominations (face value) of $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000. Generally, a client may spend up to $30,000 (that is, $60,000 face value) per calendar year on paper bonds. The federal government began issuing electronic bonds in May 2003. Electronic bonds are not issued at a discount, but rather are issued only at face value. Generally a client may spend up to $30,000 per calendar year on electronic bonds. The chart below summarizes the annual purchase limitations: Paper Bonds Electronic Bonds Total Annual Limit Face Value Cost Face Value Cost Face Value Cost $60,000 $30,000 $30,000 $30,000 $90,000 $60,000 A rate of interest, calculated as 90% of the six-month average of five-year Treasury securities, is applied to the bonds semiannually, resulting in an interest rate that varies over the life of the bonds. …