Tired of low CD rates? Try savings bonds
CD rates are so low that U.S. savings bonds -- yeah, savings bonds -- have become a better investment.
What the Treasury Department calls Series I Bonds are the best.
They're paying 3.36% right now, which is far more than the best nationally available six-, 12-, 24- or even 36-month certificates of deposit.
Indeed, only a few top-paying, five-year CDs can beat that return.
Although the interest rate on Series I Bonds resets every six months to reflect the current rate of inflation, it's hard to imagine the Consumer Price Index will decline anytime soon.
If you insist on a fixed-rate, Series EE Bonds are paying 1.2%, which still beats the average return on six-, 12- and even 24-month CDs.
Savings bonds won't tie up your money for a long time, either.
You can cash them in after 12 months by paying a modest penalty of three months' interest. After five years, there's no redemption penalty.
Let's say you only kept the bonds for 15 months. Your annualized return would still be 2.68%. You can't earn anywhere close to that with the best 12- or 24-month CDs.
We're sure this will surprise many savvy investors, who only buy savings bonds as gifts for weddings, birthdays or bar mitzvahs.
But the Federal Reserve has been pushing interest rates artificially low as part of its effort to rescue the banking industry from its reckless lending binge of the early 2000s -- and the economy from the recession that followed.
To do that, the government-controlled bank has dropped what it charges commercial banks to borrow money to rock-bottom levels -- 0% to 0.25% for overnight loans.
With the Fed providing an almost endless amount of free money, the banks can pay so little for our deposits that savings bonds have become a competitive alternative.
Savings bonds have several tax advantages over CDs, too:
- You don't have to pay tax on the interest you earn until the bonds are redeemed. With CDs, you're taxed on the interest in the year it's earned.
- The interest earned on savings bonds is exempt from state and local income taxes. That's a big plus for residents of states that levy a hefty tax on investment income, such as California and New York.
- The interest can even be exempt from federal income taxes if the bonds are used to pay for eligible college expenses. (See IRS Publication 970, Tax Benefits For Education.)
The easiest way to buy savings bonds is at TreasuryDirect and have them issued electronically to your account.
Or you can still purchase the familiar paper savings bonds at most banks or through payroll deduction plans where you work.
Unfortunately, the government will only allow you to invest $5,000 a year in a single type of bond, under a single Social Security number.
The reduction from the previous $30,000 annual limit was made in 2008, supposedly to refocus the savings bond program on individuals with relatively small sums to invest.
But it's possible to buy $5,000 worth of I Bonds online, and another $5,000 worth of paper I Bonds, with a single Social Security number.
Or you can buy $5,000 worth of I Bonds online, and another $5,000 worth of Series EE bonds online.
One final quirk about the savings bond system.
All Series I Bonds and Series EE Bonds purchased electronically are issued at face value. So if you pay $1,000 for a bond, it is immediately worth that much.
Paper Series EE bonds are issued at half their face value. You will pay $500 for a $1,000 bond, but it will not be worth its face value until it matures.