This is the second of two parts on the plusses and minuses of EE savings bonds. The first part dealt with everything except after tax rates of return. Previous posts on savings bonds covered the now defunct Series E bonds, the basics of Series EE Bonds, the basics of Series I Bonds and how to buy and sell savings bonds.
Rates of return: In evaluating a Series EE bond’s rate of return, the major question you must answer is whether you for sure you will hold the Savings Bond for at least 20 years. If not, your rate of return on a bond bought today is 1.4%. If you do hold the bond and cash it out at exactly 20 years, your return hops up to 3.5%—a big difference.
Current CD rates for five years are running in the 2.2% –2.5% range—well over the 1.4% you can earn on an EE bond. The interest rate for ten-year CDs is a bit over 3%. While longer CDs are sometimes available, they usually come with call provisions attached and so are not strictly comparable.
Thus, compared to CDs, if you are going to hold the EE savings bond for ten years or less and are fairly confident you will not have to cash in the CD before it matures (or you buy it at a local bank that allows for cashing in the CD with a modest penalty) then a CD generally provides a better deal. Even, if you don’t plan to touch the money for 20 or 30 years, finding a CD to buy for the whole period will be difficult.
Not so with Treasuries, where we can find maturities up to 30 years. To make rate of return comparisons between EE savings bonds and Treasury securities more accurate, we’ll compare EE bonds with Treasury “strips.” Strips are treasury securities that have had the interest payments removed so they only pay the face value of the bond at maturity. Like a paper EE bond, they sell at a discount and pay off full value at maturity. The difference between the purchase price and face value is its return, which is equivalent to a savings bond’s accrued interest.
Strips that mature in about five years currently yield 1.6-1.8%., a slightly higher return than an EE savings bond held for the same period. If we increase the maturity to 10 years, the yield on Treasury strips rises to 3.1-3.3%—much higher than you get with the current EE bond. At 20 years the yield is 4.0-4.1%, still higher than the 3.5% return you receive from the EE bond.
Taxes: We can’t ignore taxes in this deal. Savings bonds and Treasuries are both taxed at the Federal level, but not by states or locally. Series EE bonds allow you to defer taxation on the interest earnings until you cash in the bond or at the end of 30 years when it matures and stops paying interest. Most people choose to defer taxes, but you can elect to pay taxes each year on the interest earned during the year. If you make this election, it must apply to all savings bonds you own.
Treasury strips do not allow you the option of postponing taxes. Each year you are taxed on the implied interest you have earned during the year. Since you do not receive any interest until the Treasury matures, you must pay the taxes from other sources.
If you think income taxes will increase, paying taxes earlier isn’t necessarily a bad deal, but otherwise you lose out in some of the compounding effects of tax-deferred returns (the reason traditional IRAs are preferable to holding money in a taxable account). However, given the current microscopic returns on bank accounts these days the benefit of deferring taxes (assuming constant tax rates) is fairly small.
In summary, tax effect is an advantage of savings bonds; but at today’s interest rates, and assuming constant tax rates, the effective rate of return on Treasuries is greater than Series EE bonds.
Conclusion: There is no simple one-size-fits-all answer. Compared to CDs and Treasuries, the main advantages Series EE bonds have are simplicity and that you can buy them with as little as $25. You can transact your business online or at a local financial institution and everything is relatively easy—which seems to be what Congress intended.
If you expect to hold the savings bond for only a few years, this simplicity might be worth enough to give up a few basis points of return relative to Treasuries. But buying a CD from your local bank isn’t very difficult and will pay better—just make sure you can cash in the CD early (with a prepayment penalty) should the need arise.
If you expect to hold the savings bonds for ten years or more, you are giving up a lot of return compared with buying Treasuries. Even if you don’t yet know enough to buy Treasuries on your own and have to pay a broker to help you buy and sell them, they still should provide much more value the Series EE bonds. The biggest caveat here is that with the extra return comes the extra risk if you must sell the Treasury before it matures and you become subject to market risk.
Next up: Plusses and Minuses of Series I Bonds.
~ Jim
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