The U.S. Treasury Department recently took the ultimate plain vanilla investment and gave it some chocolate chips.
Welcome the I Bond, or inflation-indexed savings bond, a tool that does not revolutionize this realm of conservative investments so much as it offers a new option and a reason to re-evaluate a savings bond portfolio.
The I Bond, which won’t be available until September, is designed to guarantee a set return after inflation. The Treasury will set a fixed interest rate, and then add to it an extra payment pegged to the consumer price index for urban workers.
It is modeled after the inflation-indexed Treasury bonds the government unveiled last year, mostly to yawns from the investment community.
For the savings bond investor, the development is not insignificant. Instead of going into a bank to buy a bond, an investor must now choose between the traditional Series EE variety and the newfangled I Bond.
“Given the current inflation outlook, I don’t think it will be very popular, at least not right away,” says Daniel J. Pederson, president of The Savings Bond Informer, a Michigan company that helps investors value their bond holdings. “But if inflation rises, this will be worth a look, and it gives everyone a reason to consider this option against the savings bonds they have now.”
Currently, it’s hard to tell just how good a deal the I Bond will be. Treasury has yet to say what the fixed interest rate will be.
But Deputy Treasury Secretary Lawrence Summers did say he expects the initial fixed payment to be set between 3 and 3.75 percent.
So let’s assume the fixed rate is 3.5 percent. If inflation is 1.5 percent, the I Bond would pay out 5 percent. Series EE bonds purchased after May 1, 1997, pay 90 percent of the rate paid on five-year Treasury notes, currently just over 5 percent.
So a savings bond investor who figures inflation over the next five years or more will rise at a rate of about 2 percent per year would probably bet on the I Bond. Anyone expecting the kind of low-inflation environment that has been prevalent for the last several years would go with EE, betting that the higher guaranteed yield will generate a better real return after inflation.
Otherwise, the I Bond is virtually identical to its EE counterpart. It is exempt from state and local taxes; federal taxes can be deferred until the bond is either redeemed or stops earning interest after 30 years. (Part or all of the income on bonds can be excluded from federal taxes if the proceeds are used by qualified taxpayers for tuition and fees at eligible educational institutions.)
The I Bond’s interest rates will be set May 1 and Nov. 1, and it can be purchased and redeemed in all of the same places that sell the EE bond. Like the EE, the new bond can be redeemed without penalty after five years.
There are two other noteworthy differences in the I Bond:
– It will be sold at face value, and accrue interest from there. So a $50 inflation-indexed bond will sell for $50. A $50 EE bond sells for half of its face value, or $25, and then matures over time
– An individual can purchase up to $30,000 in the new bonds per year, compared to a top limit of $15,000 on the traditional bonds.
Summers expects the bonds to be popular with people saving for college or retirement, big long-term goals for which inflation protection is a plus. Inflation-indexed Treasury bonds with the longest duration, 30 years, have attracted the most interest; shorter-term bonds have been less popular because the investment community has not been forecasting a return to widespread inflation.
There is no rollover provision for savers with EE bonds to convert to the inflation-protected variety. Making the switch would require selling the bond, taking the tax hit and then reinvesting the money.
But that concept is something bond investors should explore, not because the new bonds are so terrific but because the current yield on their old bonds may be so low.
Pederson noted, for example, that the biggest month ever for savings bond sales was October 1986, when a new bond was guaranteed to pay 7.5 percent annually for 10 years.
Now that the 10-year guarantee period has passed, those bonds are earning just 4 percent, or 20 percent less than a newly minted EE bond, and less than the anticipated I-bond rate.
“Depending on when you bought a bond and what the terms on it are, there are specific instances where you could be earning less than what is available in other very conservative investments,” says Pederson, the author of “Savings Bonds: When to Hold, When to Fold and Everything in Between.”
That being the case, Pederson and others suggest evaluating a savings bond portfolio to see where the bonds stand. Examine guaranteed rates of return and how long those rates will be in place, along with what happens to the bond’s earning power once the guarantee period passes.
For example, the guaranteed rate was set at 6 percent for 12 years on bonds purchased between November 1986 and February 1993. Once the guarantee passes, the rate drops to 4 percent.
A saver who purchased a bond six years ago, therefore, has three choices. One would be to redeem the bond now penalty-free. Another would be to leave the money in place for six more years while the guarantee is in place before moving it elsewhere. The other option is to let the money ride, which could literally be the poorest choice of all.
FOR WHAT IT’S WORTH
If you need help finding out what your savings bonds are worth, here are places to turn:
– Savings Bond Wizard is a free computer program developed by the Bureau of the Public Debt that lets you keep a record of the value of your bonds. It can be downloaded from the Bureau’s Web site, www.savingsbonds.gov.
To get a table of savings bond redemption values, send a postcard with your name and address and the form number (PD 3600) to the Bureau of Public Debt, Savings Bond Operations Office, Parkersburg, W.Va. 26106-1328. The table can help you find your bonds’ value to the penny.
– The Savings Bond Informer Inc. is a private company that, for a fee, provides a written report on the value of your savings bond portfolio. Call 800-927-1901.
In addition, the Informer is planning to offer an evaluation of the new inflation-adjusted savings bond. It will be available once the Treasury announces the fixed rate that applies to the bond. For a copy, send a self-addressed stamped envelope to Savings Bond Informer, P.O. Box 9249, Detroit, Mich. 48209.
