7 Reasons Why I Savings Bonds Are a Good Choice for New Investors

by Michael Kling on 20 September 2013 1 comment

For new investors worried about risk and challenged by high minimum requirements, U.S. Savings Bonds, particularly I Bonds, offer a great alternative. When you buy a Savings Bond, you essentially lend money to the U.S. government, which pays you interest in return. (See also: 5 Super Safe Investments)

An I Bond interest rate is a composite of a fixed rate that stays the same and a variable rate that changes every six months based on the Consumer Price Index. The combined rate will never be less than zero, even if there is deflation and prices are falling. Interest is earned monthly and compounded twice a year.

The government also offers EE Saving Bonds, which are similar to I Bonds, but pay fixed interest rates. EE Bonds offer the same safety, tax advantages, and low minimums as I Bonds. However, because EE Bonds sold since 2005 feature fixed rates, they don't offer the same protection against inflation.

Here are seven reasons why I Bonds are a good investment.

1. Safety

They are safe. Stock prices rise and fall, sometimes substantially. Their proponents say stocks offer the best long-term return, but stocks can drop or remain flat over long periods, like the 1970s or early 2000s. Bonds are generally seen as safer, yet bond values fall when interest rates rise, meaning you can lose money.

I Bonds are arguably even safer than bank CDs and savings accounts insured by the government (FDIC). Instead of keeping your money in bank accounts insured by the government, you lend it to the government itself.

2. Low Minimums

A Savings Bond can be purchased for as little as $25. By comparison, bank CDs typically require at least $500 or $1,000. Mutual funds require at least $2,500. Some want $5,000 to start, a tough hurdle for beginning investors.

3. Favorable Tax Treatment

I Bond interest is not subject to state or local income tax. You don't pay federal income tax until you redeem them and pocket your interest. (See also: Tax Penalties for Early Retirement Withdrawals)

4. Deductible Educational Expenses

You may be able to avoid paying taxes on your interest if you have "qualified education expenses." Qualified expenses include tuition and fees and expenses paid for a course required for a degree or certificate, but not books or room and board.

Educational expenses for your child can qualify if the bond is registered in your name or spouse's name. Expenses for your spouse may qualify if you file a joint return.

5. Inflation Protection

I Bonds can be used to protect yourself against inflation because their interest rate is adjusted twice a year based on the Consumer Price Index. So if inflation increases, the bond's interest payment also increases, an important consideration when many investments lose value due to inflation. (See also: Savings Rates Below Inflation? Save Anyway)

6. Retirement Income

Because they keep paying interest for 30 years and offer favorable tax treatment, I Bonds can be good source of supplemental retirement income. Favorable tax treatment is another retirement advantage. Since you only pay taxes on interest when redeeming the bonds, you could postpone taxes until you're retired and possibly in a lower tax bracket. (See also: Retirement Planning If You're Under 30)

7. Convenient to Buy

To purchase Saving Bonds, you have to set up an account at TreasuryDirect.com. Once the account is set up and linked with your bank account, buying them is as easy as a few mouse clicks. You don't have to worry about storing paper bonds. You can also set up an automatic payroll savings plan, if your employer participates in a plan.

You can use your tax refund to buy paper I Bonds in multiples of $50 up to $5,000. All you have to do is select the option by filing Form 8888. Except for I Bonds purchased with tax refunds, Savings Bonds are only sold electronically.

I Bonds have some drawbacks. You have to hold them at least 12 months before redeeming them. And if you redeem them within five years, you lose the last three months of interest.

Their rates are not spectacular. For instance, the composite rate, or combined fixed- and variable-rate, for I Bonds issued May 1, 2013 to Oct. 31, 2013, was set at 1.18 percent. Still, given their other advantages, I Bonds are a good choice for new — as well as experienced — investors.

Have you ever invested in I Bonds? Would you consider it?

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Victor

I started investing with buying I Saving Bonds, was too much taken away by the ‘risks’ in stock market investing. Years down the line in making investments, I realize that most of it was mere exaggeration. By the way, great post. It covers almost everything that a new investor would want to know.