What do savings bonds offer?
The global economy continues to experience slow growth, making it a lower priority for most consumers to focus on long term planning.
In a lot of cases this is understandable.
However for the select consumer with some money to spare, US savings bonds, Canadian or other savings bonds offer a fantastic investment opportunity.
The basics of savings bonds
The amount of information (both basic and technical) on savings bonds on the internet is massively overwhelming. If you don’t have bloodshot eyes and a confused brain after 2 articles on how savings bonds work then you most likely will after 10.
As a quick guide, this article aims to simplify this knowledge.
“US savings bonds are debt securities issued by the US Treasury to help pay for the government’s borrowing needs. They are considered one of the safest investments because they are backed by the full faith of the US government.”
Simply put you can divide savings bonds into two different categories: EE bonds and I bonds.
EE bonds and I Bonds
EE bonds are often seen as the most common type of savings bonds for people to acquire.
Essentially you buy the bond at half of its face value.
So, if you want $10,000 worth of savings bonds then you would put up $5000. You will be given a fixed rate of interest that will be paid on the EE bond. This was changed from a variable rate in 2005, and based on this interest you will have a maturity date.
Interest rates have been low (as most savers know) and as of the 1st of November 2013, all EE bonds purchased between this date and April 30th 2014 will have an interest rate of 0.10%.
In principle your interest rate over the 20 year period will work out to around 3.5% leading to the doubling of the value.
I Bonds work a little differently.
They have two components: fixed rates (0.20% as of 11/01/2013) just like the EE bonds but they also have a variable rate that is designed to protect you against inflation.
So rather than your I bond value being gobbled up by excessive inflation, it will rise in accordance with the inflation index.
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Tax and your savings bonds
One of the biggest issues that people consider when contemplating the purchase of bonds is how this affects their tax status.
Basically the tax man will leave your I-savings bonds alone until they mature. The I-series bonds mature in two ways: either after 30 years or when they reach their maturity value. So if you put away that $5000 and it reaches its $10,000 target in 15 years you don’t have to pay tax on any of this accrued amount until it matures.
Essentially what you are doing is deferring your tax hit for a number of years until your bonds mature. Indeed, they are also exempt from both state and local income taxes.
The same goes for the EE bonds. They also come with a 30 year interest period and you can defer your tax on these savings until they hit their maturity value.
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Using your bonds for higher education
A lot of people choose to buy bonds as a birthday present especially for young children.
A 3 year old is hardly going to appreciate the value of this. However 15 years down the line when they are looking at university options, this investment could be one of the best you made on their behalf.
This is due to rules in the tax law that not everyone is aware of.
As we stated above, you don’t pay tax on either EE bonds or I savings bonds until they mature or until you cash them out, however you can waive this tax if you pay for higher education.
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It works like this. Assuming your parents bought bonds in your name when you were 3 years old. They mature over the next 15 years and their value pays for your tuition fees.
If your enrollment in higher education falls in the same tax year as when you cashed out on the bonds then you can come under what is known as the education tax exclusion.
In essence, instead of the tax man getting his hands on his share of your savings that have accumulated over the past 15 years, he gets nothing and it all goes towards paying for your education.
There are some finer details to this and things like buying books for class or paying for your board aren’t covered in this education tax exclusion scheme. However, your basic tuition fees are.
Bonds offer a safe and long term investment strategy
We’ve already touched on the ‘now, now, now’ attitude that is very prevalent in your society. We want everything and we want it right away. If it were that easy everyone would be rich and doing well for themselves; the reality is different.
When talking about the best savings bonds the topic of the stock market always comes up. There is an almost romanticised view of buying and selling stocks and making a quick buck.
While some people are very successful at doing this, for a lot of people it works out just as bad as putting your last $20 on a horse that hasn’t won a race in 5 years.
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What the EE bonds and the I bonds offer is a long term investment strategy that might not be the most exciting journey in the world but one which is steady and guaranteed.
The savings bond rates change every year, although rarely do so drastically, and the rate that you get when you purchase the bonds is what you’ll get until you cash out (although the I savings bonds have the inflation protection).
So, which of these two is the best value savings bond?
Both have their qualities. The government guarantees that the EE bonds will double in value after 20 years whereas you have the added protection against inflation with the I series bonds.
Think of it like this: you can go through life with several spikes that bring euphoria and joy but also several dips that bring depression and helplessness with no guarantee of anything at the end, or you can go steadily on your way knowing that the reward is coming further down the line.
If the latter sounds like you then you can see why savings bonds are the smart investment strategy for your future.
Looking forward to your comments below.
– Alasdair S.